Do Indian Markets seem Overvalued?

I have this peculiar problem.

I start feeling uneasy when stock prices keep rising. And many people close to me find this odd as they think that me being an investor, rising prices should make me happy.

But that is how I am – I prefer to buy when prices are down and not very high. And that’s the only way to buy low and sell (if I want) high.

Isn’t it? My prayers are a bit different. 🙂

But for now, lets focus on current times…

Major Indian indices (Sensex, Nifty) are close to new highs.

If I go according to historical valuations, the markets are clearly overvalued (click for current valuations). And investing in overvalued markets results in unacceptable returns… atleast generally speaking.

Have a look at the table below:

This is a snapshot of 3, 5, 7 and 10 year returns of Nifty based on the index PE at the time of investment. The trend is clear and you can read about it in detail in this comprehensive Annual PE analysis I do every year.

But to summarize, lower the PE (i.e. market valuations) at the time of investment, higher will be your chances of getting great returns. Sadly, vice versa is true too.

Given the fact that markets are overvalued, we also need to understand two more things. And these are very important:

• An overvalued market is no guarantee of correction/crash in near future.
• There will always be pockets of investment-worthy stocks available even in overvalued markets.

Let that sink in. Read it again for better effect.

As of now, there are two strong views in the market.

View 1: Markets are clearly overvalued and ripe for correction. So position your portfolio accordingly.

View 2: Markets are richly valued but economy is undergoing structural changes that make the markets ripe for a bigger bull run (maybe a grandmother of the mother of 2003-2007 bull run).

Which is right?

Life is not easy and honestly speaking, both arguments look quite sensible.

So with rising valuations of equity in recent times, what should be done going forward?

I don’t have the perfect answer here.

But my personal views are what I can write about.

I know that its wrong to completely base your investment decisions on past data. But ignoring history is not my cup of tea. I can’t turn a blind eye and say that its different this time. Generally, its never different.

Its easy to find people making easy money in stocks these days. Most of them believe its their stock picking skills instead of acknowledging that it is this rising tide that is lifting all boats, even leaky ones (read shitty stocks). Happy for them till its working for them.

But high valuations make me uncomfortable. And basing my decisions on this theory has worked well for me in last decade or so. So I will stick to the basics.

What am I doing?

For my strategic long term portfolio (which is more about personal financial goals), I continue to hold my asset allocation at roughly 75-80% equity. Though equity component has increased a lot in last few months and I rebalanced it a bit.

As for my tactical portfolio (where I try to prove it to myself that I am a great investor), I have reduced my equity exposure. Its down from mid 90s to early 70s. It was getting a bit difficult to find attractive opportunities and hence, I am increasing my focus on Return of Capital and not Return on Capital.

Holding cash (or debt) allows me to take advantage of opportunities that may present themselves in future (read about Three Cs). And as Warren Buffett says, it’s better to wait with a loaded gun for rare elephant-like opportunities, than have no bullets in the chamber because we have wasted them on smaller animals. Being in cash can seem stupid in short term but incredibly intelligent in long term.

Easier said than done but I keep trying. 🙂

For me, it was not easy to cut down exposure to some stocks which were still doing well. Just like its tough to leave a party before it ends. But I think, rising markets are the time to be sensible and lower our future expectations and do what is right. I reduced or exited from positions I was not very sure of.

Some people are still ultra-bullish inspite of the high valuations. They forget that they are investors and not economists. 🙂 And with all the positive noise coming from such people – about numerous aspects of the economy and various sectors, I am regularly reminded of Benjamin Graham’s one hell of a sensible quote:

“Obvious prospects for physical growth in a business do not translate into obvious profits for investors.”

Please note that whatever I have written till now doesn’t mean that I am not a believer of the Indian equities in long term (read next 20-30 years). I am still heavily invested into equities as you can see from percentages mentioned above. But I just want to be little careful about things given the run-up in recent times.

Infact, when I told a close friend of mine about me reducing exposure to equity, he was surprised. According to him, it didn’t make sense as markets were rising and I should be investing more. Only time will tell who ends up right. Though I bother more about being rich than being right. 😉

As of now holding more cash that earns nothing much may not look like the best thing to do. But its still better than holding something which has a high chance of going down in near future.

Before I close, please understand that there is a difference between something being overvalued and something being in a bubble. I still don’t feel (and I may be wrong) that we are in a bubble at broader levels. Bubbles are when prices go from stupid to very stupid to Oh-My-God stupid in no time.

But no doubt these are good times for the stock markets.

So lets thank god in these good times and remember equities again in bad times. 🙂

Its not easy but lets try.