The hottest topic to discuss now days is – Is it good time to BUY or SELL? Well, this can be answered with following observations.
Last month, two major developments boosted the market sentiments. The first one from US where Fed rates and commentary were on expected lines. No negative surprise is sometimes construed positively by the markets. Other Central Banks around the world maintained lenient view on money flow, thus boosting confidence for availability of ample liquidity. Domestically, a huge mandate given to BJP in state elections increased the confidence in market participants about major reform announcements on fast pace. Also, GST is confirmed to be implemented from 1st of July, 2017. These positive events pumped up “hope” of earning revival with a promise of abundant liquidity, leading to markets touching all time high.
On the negative side, some concerns remain like Brexit, fragile economic growth in Europe, slowing growth in China and huge amount of outstanding debt which is trading at negative yields! Nobody knows how the events will unfold on these fronts.
Though we are cautiously optimistic about earnings growth revival, we believe most of the positives are already discounted by the markets. Globally, markets are trading close to all time high in terms of valuation. Below are the charts to validate high valuations:
1) Price to Sales ratio of Dow Industrials: Close to all time high during tech bubble
2) Forward PE Ratio of Global Markets
Although, the above chart is showing forward PE multiple (which is calculated on expected earnings growth rate), not too far from long term average, we would remain cautious on that. The expected growth in EPS for the last 3 consecutive years has sharply disappointed markets and analysts.
Trailing twelve months (TTM) PE of Sensex at current levels is at 23x which is widely stretched from its 10 years average of 18-19x. And this is on the back of paltry 6% earnings growth rate. In a bull run of 2004-2007, EPS growth was more than 25% annually. Historically, any investment made in Sensex when PE level is more than 19x results in very low returns over the next three years. Please see the table below:
So is it good time to BUY or SELL? These expensive market prices deter us to take new exposure to equity markets from a value investment perspective. However, the circle of good and bad news is in inevitable in markets, as it is in life. Once or twice every year, Sensex corrects by approximately 10%. We thus await these opportunities to take fresh equity exposure in portfolios with schemes having large cap orientation. We are completely avoiding mid & small cap space due to extremely high prices that resulted in many mutual fund houses to stop accepting new investments in their small & mid cap schemes. Although, an overpriced market can continue to remain overpriced for a considerable long period of time but these are not the best times to make investments.
For portfolios with old equity allocation, we would recommend trimming exposure from pure mid & small cap schemes and to maintain some cash levels to take benefits of any market correction.
On the Debt side, the market yields are not expected to go down. We therefore would not recommend any new allocation to long term debt funds. Ideal debt funds for investments would be ultra-short term for a period of less than 3 years and accrual debt funds for a period of 3-5 years. The quality of the portfolio remains the key here.
As we know that markets are uncertain and it can go in either direction, principle of Margin of Safety i.e. buying at a price that limits the downside is very important factor to consider before making investments in equity market. The risk is not in asset classes but in the price at which we have made investment.
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