Should you book profits now?
Last updated: 16 Dec, 2020 | 03:44 pm
The headline indices have soared to fresh record highs. Nifty has risen by over 11% in the last one month alone, leading one to ask whether it is the right time to book some profit.
Markets have become extremely expensive
Over the last month, the markets have risen on various factors starting from signs of economic recovery in October, US election outcome, and the news around vaccines. However, over the long term the direction of the market will be driven by earnings. Considering this, the market is expensive on nearly all measures: P/E vs own history, ERP (Equity Risk Premium), and World & EM. View Chart below:
- If Nifty, FY22 and FY23 EPS stay unchanged, P/E on Dec-21 will remain the same as in Jan-20, according to estimates by Credit Suisse.
- Therefore, for the market to rise, upgrades are needed to FY23 EPS. This is difficult given past history, as stocks don’t have earnings visibility.
- Further, With 12M forward P/E multiples nearly 20% higher than on 31-Jan 2020, with a broad-based increase in P/E multiples, the recovery is priced in (according to the brokerage)
- According to an Oct-20 report published by RBI, returns in Indian stocks over the past few years came due to a decline in equity risk premium (ERP) rather than earnings.
- Equity Risk Premium represents the extra return that investors demand in return for holding a risky asset.
- A lower ERP implies that stock prices are being driven by investor confidence in equities (hence a lower equity risk premium) rather than earnings upgrades of the underlying stocks. This has contributed to higher valuations in terms of P/Es.
- The risk premium in India is now at a record low. RBI estimated that the long-run ERP for Indian stocks was at 4.7% between 2005-2020.
India and Emerging Markets
- The chart above indicates that Nifty is currently trading at 34% to MSCI Emerging Markets index and 88% premium to the MSCI world index, in terms of P/E ratio.
- According to data from Bloomberg, based on FY22 earnings, the current price to earnings (PE) ratio of MSCI India is at 22.37 times while MSCI EM is at 15.12 times, which makes India one of the most expensive markets.
- According to Macquarie, there are significant earnings downgrades ahead. Indian companies are set to miss earnings estimates for the 11th year in a row. Further, the firm reckons that the estimates for FY22 are wildly optimistic.
Our proprietary VGQM model has a ‘Neutral’ rating on the Nifty 50, indicating that the ongoing rally is not supported by fundamental factors. Therefore, we advise you to:
- Book profit in case of significant gains and avoid lump-sum investments in the stock market
- Stagger your lumpsum equity investments into smaller fractions before deploying into this market
- Continue your SIP investments
- Stop large lumpsum investments into NIFTY ETFs