Is the Market Overvalued?

Sensex and Nifty have hit lifetime highs with the Sensex moving past the 41,000 mark. In this article, we find out using long-term technical indicators if the market is overvalued.

Published: November 27, 2019 at 12:28 pm

Last Updated on December 29, 2021

On Nov 26th 2019, both Sensex and Nifty hit lifetime highs with the Sensex moving past the 41,000 mark. In this article, we find out using long-term technical indicators if the market is overvalued.

To do this, we shall adopt three different measures: (1) Trend via moving averages (2) Volatility using Bollinger Bands and (3) Valuation using PE, PB. The charts shown in this article (including other metrics) can be reproduced by readers via this tool: Nifty Valuation Tool: Find out if the stock market is expensive or cheap in multiple ways

State of the Market: Nifty Nov 2019

Exponential moving averages: Nifty

The daily moving average (DMA) is a simple measure where we compute the average of the last six month or last one year daily prices. The exponential moving average (EMA) is based on the simple moving average but give more weight to recent performance.

Notice that the Nifty 50 price is well above both the 6,12-month exponential moving average with the 6-month EMA above the 12-month EMA. This is the large cap segment is overvalued. However, (1) this indication alone is not enough to make conclusions and (2) it should be kept in mind that although a correction is possible it need not be significant.


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In the same picture, prior to the Nov 2019 movement, one can count four such corrections. None of them was significant.

State of the market Nov 2019 exponential moving averages of the Nifty

Bollinger Bands: Nifty

Bollinger bands are two lines drawn above and below the 200 DMA. The bottom line or lower band as it is called is two moving standard deviations below the 200 DMA. The upper band is two standard deviations above the 200 DMA. Created by John Bollinger, they combine “trend” and volatility.  A description of how they can be used is found here:

The current state of the Nifty is shown below. Although the price is above the top band, notice the top and bottom bands have converged indicating lower volatility.  This indicates a neutral position: neither overvalued nor undervalued.

Bollinger Bands of the NIfty Nov 2019

Nifty PE

The 10-year average of the Nifty and +1,+2,-1,-2 and standard deviation above/below the average are shown below. Over the last 11 years, the 10-year NIfty PE average has moved up from a little less than 18 to about 22.  So the definition of a “high PE” is continuously changing.

Moving Average of Nifty PE Nov 2019The current Nifty PE is hovering between the average + standard deviation (+1) and average + 2standard deviation (+2) lines. For the last five years or so, this has been the case except for two significant deviations below. So it not clear from this if a fall is imminent or not.

Nifty PB

The corresponding values for Nifty PB are shown below. The Nifty PB has recently dropped below the 10-year PB average. The PB has rarely gone above the +1 line. If we go by this chart, there is not too much room at the top.

Moving Average of Nifty PB Nov 2019

State of the Market: Nifty Midcap 150 Nov 2019

Let us now look at the corresponding chart for Nifty Midcap 150.

Exponential moving averages: Nifty MIdcap 150

The 6-month EMA is still below the 12-month EMA while the price just above both. This indicates that the market is just rightly valued.

State of the market Nov 2019 exponential moving averages of the Nifty MIdcap 150

Bollinger Bands: Nifty Midcap 150

Compared to April 2018, the volatility bands are considerably narrow indicating lower volatility with the price heading towards the top band. Again this indicates neither over- or undervaluation.

Bollinger Bands of the NIfty MIdcap 150 Nov 2019

Nifty Midcap 150 PE

The Nifty Midcap 150 PE and PE history is not as much as that of Nifty. So the ten-year average PE/PB cannot be taken too seriously. With the current PE close to the average, there appears to be good space for midcap stocks to move up.

Moving Average of Nifty MIdcap 150 PE Nov 2019

Nifty Midcap 150 PB

The current Nifty Midcap 150 PB is higher than its ten-year average. So again this means that these stocks are probably still priced high.

Moving Average of Nifty MIdcap 150 PB Nov 2019

Summary

Readers may have noticed that the inferences from different indicators do not match. This is often the case. In the large cap space, the volatility is lower than in the recent past but the PB is close one standard deviation above the 10-year average. Meaning there is not a lot of room for moving up.

In the mid-cap space, the PB again seems to indicate high-priced stocks, but this is not reliable as the history is too short. The volatility is low, but one cannot clearly say if there is potential for upward expansion. Looking at the PE alone here could be misleading.

As pointed out above, the charts shown in this article (including other metrics) can be reproduced by readers via this tool: Nifty Valuation Tool: Find out if the stock market is expensive or cheap in multiple ways

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Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over nine years of experience publishing news analysis, research and financial product development. Connect with him via Twitter or Linkedin or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation for promoting unbiased, commission-free investment advice.
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