The stock markets are at an all-time high. Why? The market pundits will attribute it to expectations of a good monsoon, favourable political shifts, GST implementation, and so on. The truth is - this rationalisation always comes as an afterthought depending on whether the markets are high or low.
If we were at an all time low instead, the media would be talking about a possible border dispute, relatively delayed and complex GST, low corporate earnings and the possibility of Donald Trump starting a World War III.
It's always too difficult to follow these changing dynamics and make sense of them. But there is one undeniable fact that cannot be refuted - Earnings.
Price to Earnings (PE) Ratio - A simple way to understand how costly or cheap stocks are.
We know how fixed deposits work right? You give the bank 100 rupees, you get back 4 rupees every year. Basically, that translates to a yield of 4%. Higher the yield, the better. Simple.
While stocks are relatively complex, they are not very different. You invest 100 rupees in a company to buy a stock. The company earns 4 rupees as profit. The yield is 4%. But let's just take the inverse of this number and you get the number 25 (100/4). This number is called the PE, or the price to earnings ratio. It basically says how many times you are willing to pay the price P, for a stock whose yearly earnings are E.
Ponder over the example above and you'll begin to understand what the PE number is all about. If last year the PE of a stock was 20 and this year it's 25, it means the price of the stock is relatively more expensive compared to the earnings. PE basically tells us one thing – Is the stock cheap or expensive? The higher the PE, the more expensive the stock is.
Why are we talking about the PE? Because the Indian stock markets are currently quite expensive! We are hitting a PE of over 25 for stocks in the Nifty 50 Index! Every single time we have hit this number, the returns have been negative in the following years. The last 3 times we hit this number, the losses the following year were more than -30%. For those more intrigued, just visit the beautiful charts here at - http://historic-pe-ratio.weebly.com/#. It gives a perspective in pictures about where the markets are.
So, here's what we recommend you should do from here:
1. Stay away from committing any major lump sum investment in Equities, especially in Mid-cap and Small-cap schemes. These are even more expensive with Nifty Midcap PE at 44 and Nifty Small cap PE at 74. Stay away! You can refer to the official exchange data here. Nifty PE/PB
2. There's no reason to stop your SIPs. Discipline matters more in investing than timing. In fact, as markets go down, you are only going to keep buying at lower prices bringing your cost of purchase down. But make sure your investment horizon is at least 5 years or more. You may see some short term trouble in your portfolio.
3. Consider parking your excess savings in Liquid/Money Manager/Ultra-short funds with a perspective of about a year. Volatility is inherent to stock markets. As prices fall, or earnings grow, the valuations will become reasonable for you to consider investing back in stocks.
Is there reason to panic?
No. Panic never works in favour of an investor. However, there is a good reason to stay cautious. Stay away from small and mid-cap schemes for one-time lump sum investments. These include the investor darlings such as Franklin Smaller companies fund and HDFC Mid-cap funds.
Consider this - Both DSP Micro-cap and Mirae Emerging Bluechip funds have stopped accepting more investments. Managing funds is how these guys make money. If they have stopped accepting more money, it's as clear a sign as it can be of everything we said above.
Unfortunately, retail investors are sometimes the subject of FOMO (Fear of missing out) and consider themselves unfortunate of not being able to invest more in these schemes. Thank your stars that the fund managers have decided to put their foot down.
Are markets going to go down from here?
Honestly, I don't know. Nifty might as well go to 10,000 or even 11,000 before it goes south. Though one thing I can say for sure, things don't seem rosy. Unless the growth engine of Indian corporates starts running full steam in the near term, we'd advise clients to not go too aggressive in the current markets. Stay invested. Stay tight. And keep investing with discipline. Just to let you know, we continue to run our own SIPs in ICICI balanced fund uninterrupted. Discipline over everything else. Always.
Where do I park my excess money?
Use liquid or money market funds for safety and above-FD returns for your surplus cash. More about them here. We like the concept of Ultra-short term funds very much. One in particular that we like is HDFC Short-term Opportunities Fund. You can learn more about the various schemes here. You can have a look at the shortlisted schemes using the filter on the same page.
Buy right. Sit tight - The guys at Motilal Oswal really nailed it with their campaign. And it is most relevant to the stock market these days. We will keep coming back to you with relevant portfolio actions as an when required.
Kushal is a SEBI Registered Investment Adviser with an MBA in finance from IIMA and B.Tech from IIT Bombay. He has years of experience as a trader, equity research analyst and index research analyst. He also has experience working with non-banking financial institutions and insurance companies and has an excellent understanding of retail products in financial services.