Has the market recovered already? Did it even crash?

Published: May 18, 2020 at 11:48 am

Last Updated on

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.

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.

Nifty PE from Jan 1999 to May 2020 with 10-year moving average and standard deviation bands
Nifty PE from Jan 1999 to May 2020 with 10-year moving average and standard deviation bands

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?

Closeup of Nifty PE with 10-year moving average and standard deviation bands from Jan 2018 to May 2020
Closeup of Nifty PE with 10-year moving average and standard deviation bands from Jan 2018 to May 2020

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?!

Nifty PB from Jan 1999 to May 2020 with 10-year moving average and standard deviation bands
Nifty PB from Jan 1999 to May 2020 with 10-year moving average and standard deviation bands

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 2020

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.

Nifty Dividend Yield from Jan 1999 to May 2020 with 10-year moving average and standard deviation bands
Nifty Dividend Yield from Jan 1999 to May 2020 with 10-year moving average and standard deviation bands

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.

10Y gilt yield vs Nifty earnings yield which is the reciprocal of PE
10Y gilt yield vs Nifty earnings yield which is the reciprocal of PE

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.

Nifty Yield Gap from Jan 1999 to May 2020
Nifty Yield Gap from Jan 1999 to May 2020

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.

Nifty 500 Yield from Sep 1998 to May 2020
Nifty 500 Yield from Sep 1998 to May 2020

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.

Do share if you found this useful
Share your thoughts on this topic at the  Reddit freefincal_user_forum

Reach your financial goals like a pro! Join our 1600+ Facebook Group on Portfolio Management! You can now reduce fear, doubt and uncertainty while investing for your financial goals! Sign up for our lectures on goal-based portfolio management and join our exclusive Facebook Community. The 1st lecture is free!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!) or you buy the new Tactical Buy/Sell timing tool!
About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. Follow us on Google News Freefincal serves more than one million readers a year (2.5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any kind of paid articles, promotions or PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 199 (instant download)
Free android apps