It has been quite sometime since my last post, and the world seems so different. The Syrian conflict, gold bouncing back, Rupee touching new lows and stocks crashing, all in just 3 months! A friend asked me if it is the right to time to invest money in stock markets, as he heard someone on CNBC that most of the stocks are at 52 weeks low. As usual, I believe no one can predict what would be the levels, but yes, one can ascertain the fundamental valuation. I validate the pricing models for derivatives where I see numerous complex mathematical models and formula, and all of them useless if they fail to calibrate to the market price. We depend on mathematical tools to predict the future, while in reality, the tools are meant to expect the future. And that is a stand-off! Not that I claim to be the primus inter pares on Dalal Street, but I look at things from a different perspective, and it is this perspective which woos me to be a Blogger.
I mentioned in my Infosys blog in the month of May when Infy was trading at 2200s, that I would like to go long when the street was shouting to go short. Well, I got richer by 40%, although it doesn't mean I am always right. As I said, I cannot predict but expect, and there is a very fine line between the two.
Let me come back to the main topic that you read on the header - Where is Nifty headed!!
Let's see how the Nifty P/E ratio and earnings look like.
You can find out the P/E levels from my blog P/E conundrum, for different combination of growth and cost of capital. From the graph, you can see the blue line which is the P/E ratio, it is above 20 for a brief period of time. For a country like India, where the 10yr Govt Bond yield is around 9%, this will make the minimum cost of capital as 12.50% for the Nifty listed companies. For for this level of CoC, we need a growth of at least 15% year-on-year. The earnings growth for period 2003-2008 is 22% y-o-y. I am not surprised that the blue line in the above graph crosses the 20 mark quite often during that period. This is also the period when India's GDP was growing at a healthy rate of 8 to 9% per annum.
Now, let's talk about the last 5 yrs, when the earnings growth have been just 7% and GDP growth has been touching lows of 4%. Clearly, with such indicators, we cannot have a P/E of more than 15. However, it would be foolish to believe that the earnings growth would remain below 10% for Nifty. I mean, yes there are challenges but the growth in earnings would at least be 10% to be on conservative side. With a positive outlook, we can expect it to be 14% per annum. Now that we have the data, lets do the maths!
So If we expect that nothing will happen i.e. no rate cuts and the growth is subdued then in that scenario the worst level for Nifty would be a P/E ratio of 15. With a positive outlook and softening of rates, I will expect it to be above 20.
Based on the above analysis, you can have your own views of how the Indian market would shape up. I believe we are very much in the neutral zone right now, but with a population of more than 1.2 billion people, I don't see that the growth story of India will ever go down the hill. I think that any positive news would certainly lift the Nifty from here and take it above 6000 level. There has been enough discussions around key global events such as Fed tapering, Euro crisis, asset bubble in china, slow down of emerging markets etc. I think none of them will have any direct impact on Nifty valuations in longer term. Yes, you may see a sudden crash, but I believe that they will bounce back . As per the sectoral plot of Nifty, you can have your own assumptions on how they will perform.
To summarize, I think that we are very much in a neutral zone right now. A negative outlook can bring Nifty down, but the downside is floored at 4900 level. Even if the market crashes, we will expect a bounce back as the Indian growth story is not yet over. I expect it to be in 6000 range if the market sentiments are neutral to positive.
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