For long, those aspiring to invest in stocks have been told that they shouldn’t try to time the market. Financial advisors declare “Your time in the market is more important than timing the market,” and urge you to take up Systematic Investment Plans (SIPs). Yes, SIPs are a good idea if you don’t have a lumpsum to invest. But what if you do?
The assertion about ‘time in the market’ is not always true. An investor who bet ₹1 lakh on Sensex stocks in December 2011, a market low, has made ₹1.71 lakh in three-and-a-half years. But his counterpart who invested in December 2007 would be left with ₹1.31 lakh after a seven-and-a-half-year wait. This is why, leading fund houses in India have lately begun to use ‘tactical asset allocation’ models which allow them to buy equities when valuations are low and sell them when they hit the ceiling. Taking a leaf out of their books, you too can use three indicators to get your timing right.
Both in February 2000 and in January 2008, the Nifty PE was trading a shade above 28. Similarly, markets have bottomed out when the Nifty PE was at 11-12 times. You can get this information from the National Stock Exchange website, which provides historical as well as current PE multiples for its indices.
Based on this history, asset allocation funds set their own valuation triggers. The Franklin India Dynamic PE Fund, for instance, invests 90-100 per cent of its portfolio in stocks if the Nifty PE is 12 or below. It cuts this to 30-50 per cent if the Nifty PE crosses 20. At above 24 times, the fund reduces equities to 10-30 per cent. IDFC Mutual Fund, which runs an asset allocation fund, deems a Nifty PE of below 16 as the ‘cheap’ zone, that between 16 and 19 as ‘fair value’ zone and anything over that as the expensive zone. (The site has a neat tool that tells where we stand now — http://www.idfcmf.com/is-it-a-good-time-to-invest.aspx).
There are two caveats to using PE-based strategies. One, the markets rarely make the same mistake twice. Therefore, it is likely that future bull markets will top out at a PE of well below 28 times and bottom out at PEs well above 12. Therefore, as an investor, you should be worried if the Nifty PE hits 24 and probably add to your holdings at 14-15.
Two, market players (but not funds) often use a Nifty PE based on ‘forward earnings’ (earnings for the next 12 months) to gauge valuations. But ignore this measure. As ‘forward’ earnings are based on analyst projections of Nifty profits, they tend to be coloured by the market mood. If times are good, the projections will be overstated, if bad, they will be understated. This is precisely the kind of bias you are trying to avoid.
Nifty Price-to-Book Value Because corporate earnings can go through cycles, value investors like to use a different valuation parameter to get their timing right. ICICI Pru Mutual Fund, for instance, uses the market’s Price to Book Value (P/BV) to decide whether to add to or reduce its equity allocations under its Dynamic Fund and Balanced Advantage Fund. A low P/BV indicates that markets are under-valuing the hard assets (like plant, machinery, land) companies own. On a P/BV basis, in the past, Indian bull markets have usually peaked at five to six times and troughed at 2-2.5 times.
Thus, add to your equity portfolio if the Nifty P/BV is at 2.5-3 times and take profits off the table at 5 times or more.
Mid-cap, small-cap behaviour Another indicator that fund houses use to decide whether the market is overheated is how mid and small-cap stocks are priced relative to large-caps.
In the past, whenever the PEs of mid and small-cap stocks have overtaken the Nifty/Sensex, it has meant trouble for the market.
Here, track the PE of the CNX 500 index. . When market conditions are good for investing, the CNX500 PE trades below the Nifty PE. If the market’s close to bubble zone, though, the CNX 500 PE overtakes the Nifty PE.
This catch-up has happened on all three occasions when Indian stock markets reversed from a bull run in the last 15 years — February 2000, January 2008 and March 2015.
But here, note that the CNX 500 PE can remain poised above the Nifty for months together before the market cracks.
So, based on all these indicators, is this a good time to invest? Well, the timing is not great because the Nifty PE is 22.1 and the CNX 500 PE hovers above the Nifty’s at 23.6 times. On a P/BV basis, the market is at a middling 3.4 times. It’s best not to jump in with a lumpsum now. Either put that in a bank account and do a SIP or wait for those valuation indicators to flash a brighter green.