MARKETS ARE NOT CHEAP IN BULL MARKETS

If you want to buy cheap please wait for the next bear market, stocks will be very cheap then, but you will not want to buy. This is possibly not the right sentence to start the article however when I am continuously bombarded by questions like, markets are at a PE of 28 now it can only fall, markets are rising only because 10 stock are rising etc then this is the only way to make people understand that Bull Markets sustain and thrive only because people are sceptical of the move

Specific to the Indian context I can confidently say that we are no where near the peak of the markets as there are too many concerns today i.e.

  1. Markets have a very high PE ratio which has crossed 28 times (factually untrue) but widely propounded in the media
  2. US Fed is hiking rates; global liquidity will get squeezed and lead to a sharp fall in the markets
  3. Currency wars are starting
  4. Trade wars are starting especially between the US and China
  5. Macros are turning adverse (Whatever that means). I have frankly not seen Indian macros so strong for the last 10 years.
  6. What will happen if BJP loses next year’s elections

First coming to the facts. For very long-term investors these concerns are totally irrelevant as if you have the right stocks over a period you will always make money. However, most are lesser mortals and to that extent market timing does have a role to play in making money as human psychology makes one most negative when the actual risk is low and potential of making money is high.

It’s very simple to understand. For those of you who were in the markets in the years 2007 and 2008, answer this simple question. How many of you invested in stocks/equity mutual funds in the first quarter of 2007? I guess a clear majority. Now how many of you invested in the first quarter of 2008, I guess not more than 10% and at the first instance of any market revival most kept on selling not believing that the markets could have bottomed out. However, that is a topic (i.e. perceived Vs actual risk)

Markets are never cheap in bull markets. Period. The reason for this is that normally bull markets are accompanied by macroeconomic stability, relatively low inflation levels, improving growth outlook and increased visibility of earnings growth. During these times investors get returns both from earnings growth as well as Price to Earnings ratio expansion as there are more buyers than sellers and there is a perception that earnings growth will continue to be strong and sustained for prolonged periods of times.

We are today in that scenario. In my understanding of past market cycles markets will normally peak at Price to Earnings ratio of between 32-35 times with assumption of unsustainably high increase in the rate of earnings, a strong pickup in inflation, a growing level of leverage within corporates, unbridled lending by banks and other financial intermediaries and a feeling of euphoria. We have no such indicator at this stage. Infact scepticism is growing everyday which is not the feature of the market at the top of the markets.

The numbers being spread out are also fallacious. At a NIFTY level of 11000 we are trading at around 18.5X this year expected NIFTY earnings of Rs 600 and not at 28 times. Even if we assume that earning growth will not be 20% (which looks likely) but just 10% its at 20X earnings and not 28X. Is this cheap, maybe not but it is not end cycle valuation for sure.

Secondly, we have just entered the earnings revival cycle which will last for a few years. Even if we assume hypothetically that Narendra Modi will lose next year the revival will go on as the structural changes related to clean up of bank balance sheets, NCLT and GST implementation will go a long way in sustaining the growth and earnings cycle. However, this is not my base case and I believe that NDA under Narendra Modi will be back, and we might have a longer upcycle than usual.

To conclude I will say that during a bull market there is earning revival and PE expansion and, in this phase, markets will always be expensive. We have seen valuation expansions in many NBFC’s, Consumer names etc. There will be valuation expansion in many other sectors going forward and those will be the stocks and sectors that will give outlandish results. Most of the companies that I have talked to after the current quarter results talk about very strong growth, need for expansion and a return of pricing power. This is not exactly the kind of indicators that point towards the end of the expansionary cycle.

There are no indicators today which point towards being near the end of the Bull Market let alone being at the end. So, does this mean that markets will not correct, there will be no sector rotation etc. Of course, there will be but that is why equities are a risky asset class which give returns much higher than risk free returns over long periods of time.

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