Last Updated on December 29, 2021 at 5:33 pm
If we look at the fall in Nifty from its early Feb 2020 levels it certainly feels like a crash. After all, we witnessed the biggest intraday fall that sent the 10-year Nifty SIP Return to 2.3%; 14-year SIP Return to 5% and we also saw the biggest intraday gain after 10Y and then a 19% gain in April. However, if you look at Nifty valuation metrics it looks as if there is a recovery already or worse it looks as if the market did not crash!
The data presented is as of May 15th 2020. Sensex is down 2.4% at the time of writing (18th May 9:35 am) so it is important to keep in mind things can change pretty fast in one way or another. Also even in normal times, market valuation signals can be confusing. So please exercise caution while processing the graphs shown below. We shall first look at Nifty valuation. The situation for mid caps and small caps may be different.
First, let us look at the NIfty PE with 10-year moving average and standard deviation bands. This was plotted using the Freefincal Market Valuation Tool. The PE is the price divided by earnings per share. A high PE represents overvaluation with respect to what the stock or index is earning.
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Nifty PE Jan 1999 to May 2020
The Nifty PE corrected from almost the plus two standard deviation line to below the minus-one std dev line and after March 23rd moved right back up close to the 10-year average.
The 2008 crash was much deeper and took longer to move back up. If you look at the NIfty PE (closer look below), the Nifty is now “fairly valued”. It was “under-valued” for just a few days like in Aug 2013! Now, is this a crash or just a correction?
Nifty PB Jan 1999 to May 2020
The NIfty PB is shown in a similar format as above. The price to book value tells you how much the index is trading for compared to what it is actually worth. The current PB is about two standard deviations below its 10-Y average, comparable to 2008 levels. So does that mean the market is undervalued?!
The NIfty PB divided by NIfty PE = earnings per share divided by book vale is at al all-time low. This is also known as book yield and is a measure of return on equity. This would explain why Nifty returns have been going southward for a while now: 15-year Nifty SIP returns crash to 8% (51% reduction since 2014).
Nifty ROE
Nifty ROE or PB divided by PE from Jan 1999 to May 2020Notice there is no sign of the crash here unlike in 2008! There is no sign of the increase in ROE bet 2013-2019 like during the pre-2008 bull run. This is why I have been saying for a while that the bull run we witnessed is mostly fluff.
Nifty Dividend Yield
The Nifty dividend yield is also around 2008-levels. The low EPS seems to be propping up the NIfty PE.
Since the dividend yield does not factor in retained earnings, one can use the inverse of the PE which is known as the earnings yield. This is stocks earnings as a “yield” (making it comparable to a bond yield). Show below is the earnings yield (1/PE) and the 10Y gilt yield.
During the 2008 crash, the gilt yield crashed and stock prices fell so much that the earnings yield shot up. In 2020, gilt yields were already on the way down before the crash and the earnings yields shot and fell back down.
We can define a Yield gap = (10-year Govt. Securities yield) X (P/E Nifty index ratio). DSP Dynamic Asset allocation fund was based on this model (it is not now). You can refer to details about the yield gap here: Dynamic Asset Allocation Mutual Funds: Yield Gap vs. P/E Ratio
Yield Gap < 1 implies stock yield < bond yield suggesting a favourable time in invest in stocks and vice versa.
Prior to the 2000s bull run when interest came crashing down the Yield Gap was < 1. It occurred for a brief while in 2008. In 2020, it never hit 1 and is now a comfortable 1.28. You can imagine why DSP moved away from the yield gap model. During a bull run (earnings-driven or fluff driven) the Yield Gap tends to be well above 1 and the fund was investing in bonds when the world was in equity. Meaning no aim, no profits! The point here is, the 2020 crash is not deep enough (as on date).
The situation with NIfty 500 is not any different.
In summary, the FEB 2020 fall, though one of the steepest in history, is as on date (May 15th) arguably more a correction from high valuations than a crash. the above analysis points out vanishing ROE from our markets and with the lockdown, it may take months or years to see a “proper” ROE driven bull market. Do not invest in equity if your goal is just a few years away! It is anyway risky, now a lot more so.
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