Weekly Market Recap
This week started off with a fresh breakout for the major indices amid corporate earnings, though the gain was limited only for two days as rest of the week there was no change in the price on NIFTY. However, two days gain was sufficient to mark a record closing.
In the week gone by, the benchmark SENSEX closed up by 345 points, or .83% at 41945. Similarly, NIFTY surged 95 points, or .78% to close at 12352, whereas BANKNIFTY underperformed significantly and closed down by 506 points, or 1.58%.
Current Outlook
Since last few weeks or so I have been expressing my cautious view on the market, especially the way indices are advancing. Though, we have seen some knee-jerk reaction at crucial levels, but prices recovered fast and inching higher week after week.
The earning season is in full swing so, now is the time to analyze the market on valuations. Fundamentally, in last few years, price earning (P/E) ratio has become one of the popular way to identify the market on the basis of valuations, but not guaranteed. In last 20 years, the average or the mean of NIFTY PE is 19.79 that has considered to be fairly valued, the price above 2 standard deviations which is 28.22 is supposed to be over-valued and below 2 standard deviations which is 11.50 is considered to be under-valued. Now, the NIFTY PE is 28.61 which is above the 2 standard deviations that indicates the way over-valued.
Historically, the price has usually remained hovered below the top of the value range and above the lower end of the value range; however, since about mid of 2016, it has not been uncommon for price to exceed normal overvalue levels and never turned to the mean. This may be the “new normal,” but, really, it’s not normal. The market, specially the indices hasn’t been undervalued since July 2009. The drop in PE is only possible if price doesn’t rise significantly and earning improve, or price fall and earning doesn’t change much.
Furthermore, technically, there is a bifurcation between the NIFTY and BANKNIFTY as can be seen in the chart below. NIFTY is at all-time high, but BANKNIFTY is way down from its high. There is a clear divergence between two. Provided financials has a weightage of 39.47% in NIFTY, shall weigh down the index going forward.
NIFTY Daily Chart
BANKNIFTY Daily Chart
Although, stocks from the cement, metal and pharma sectors looks good on the chart and seems well poised to advance substantially. Hence, I continue to have a cautious outlook on indices and financials, while looking for a buying opportunity in above stated sectors.
Conclusion
Historically, overvalued conditions leave the market vulnerable for a large correction or bear market, but P/E ratios are not a precise timing tool. They are just a way to see if fundamentals are favorable or not. These earnings ratios are intended to provide a historical context for current earnings and to demonstrate that overvaluation is not your friend.
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Stick to your Investment/Trading model; Be a Savvy Investor…!
Pankaj