Contact us

Accounting Services

Get Expert Assistance

26 Aug2021
  • By Authored by Himanshu Sharma and assisted by Bhavy Dhawan
  • Category Miscellaneous
  • Views 424

Introduction

When there are talks about intriguing topics, the future surely qualifies as one. The uncertainties and lack of facts about it makes a human mind delve deep into the ambiguity. The current scenario of the Markets touching an all-time high and the massive surge of participants makes us ponder the question, what is the stock market's future? Is the market overvalued? Is there a bubble?

This article will try to ease your anxiousness with some facts plus historical data, including judgements of the current trends and personal opinions. We will begin with the concept of valuations and the techniques involved, leading to possible future scenarios and how you as an investor can benefit from them.

Let's begin!

What is Overvaluation?

Valuing a stock is a lot different than it seems from valuing the stock market itself. An investor can perform Fundamental Analysis to value a stock by measuring its intrinsic value based on relative economic, financial and quantitative factors, but we cannot say the same for the market itself. Due to the large scale implications of every financial decision in the country and macroeconomic factors, the metrics differ for the market.

But every seasoned investor knows that there's more to analysing stocks than just looking at valuations metrics, and it is far more essential to invest in a good business than a cheap stock. We can say the same about the stock market.

Let’s first look at some of the frequently used metrics of market valuations used around the globe and try to understand their credibility and relevance in our scenario:

  • The Buffett Indicator

The Buffett Indicator is the Market Capitalisation to GDP ratio, which is named after one of the most influential investors of all time, Warren Buffett, called this ratio 'The best single measure of where valuations stand at any given moment'. This indicator works by dividing the collective value of a country’s stock market by the nation’s GDP, assessing how expensive or cheap the aggregate stock market is at a given point in time. The current valuations according to this metric are hovering around 104-105% historically, which used to remain around 80% of GDP. To give you a clear idea only time such valuations (over 100%) happened was in FY08.

  • P/E Ratio

Another closely watched metric for market valuations after the Buffet Indicator is the Price to Earnings Ratio (P/E Ratio).

It tends to show what the market is willing to pay today for a stock based on its past or future earnings. A high P/E Ratio reflects overvaluation, and guess what? Indian markets, along with global markets, are witnessing a raised P/E for the past few years. The Nifty Index P/E is trailed around 20 times which historically used to be 17 times at best, and the current figure is 25.39 as of today.

So what do we make of it? That the market seems to be overvalued? Well, it's not entirely true.

Experts point out that the buffet indicator is widely followed and works well in efficient economies like the US, but India has its unique characteristics. India's GDP does not capture many activities that are either informal in nature (including contributions by housewives) or are out of formal channel due to the unaccounted nature of transactions. If one includes this portion, then the denominator will rise. Also, in India, many PSUs and private companies (including startups) are not listed, and hence the numerator is also depressed.

Hence it is believed that the Buffett indicator is less useful for an economy like India with a substantial proportion of GDP being from unorganised and SME sectors and is outside of listed space.

As for the high and ambiguous P/E Ratio, Let me clarify that the P/E ratio is not a fact; it is an estimation. The Earnings denominator considers the past and the future earnings (which are estimated). Some might argue about the credibility of past earnings, but one massive problem exists in that also, the year 2020. The earnings had gone down drastically in 2020, causing the ratio to move up. Hence, consideration of the last 12-18 months earnings is not a good move.

The points mentioned above indicates that the credibility of the most popular market valuation metrics are in question. Hence, no one can indeed say that the markets are overvalued and expect a crash coming to that itself.

India is a stable economy with lots of growth potential, and expecting a bubble will restrict some serious money-making potential.

Alternate Approach

Investing is always about alternatives. Now that it is clear that the market situation is not as bad as it seems let us shift our focus towards options other than stock markets. If there are concerns about high pricing, bubble situation, speculative action, etc., in the market, the question arises what alternatives do we have? FD? Bonds? Real Estate?

Well, we all know about the devious nature of Fixed Deposits and how they can create a hole in your wealth, courtesy of Inflation. On the other hand, the Real Estate Sector is not as lucrative as it was a long time ago as it has succumbed to Liquidity problems, High valuations, slogged growth, etc. That leaves us with Bond Markets.

Bond Markets are also a primary market like the stock market but much more prominent in size and often less talked about, which grabs the attention of investors through the Yield mechanism. But the problem lies in the low return scenario of these markets as they are operating on a belief of low Inflation that will lead to low growth in the upcoming years. In contrast, the Stock Market is sending a completely different signal of High Inflation that leads to high growth of businesses in the future resulting in high returns.

One can argue that yield can grow in the future, but there are two types of yield growth in bond markets; First, a Knee Jerk Reaction to move money into bond markets from stock markets which is not likely to happen as this will shake the stock market and no country wants that to happen and second, a slogged growth overtime which again makes the stock market shines like the most lucrative option.

There exist no option other than to invest in businesses as they are growing with Inflation. This growth becomes the sole reason why money is and will keep flowing from various other alternatives, including Bond Markets into Stock Market, indicating its growth in the future.

What should you do?

After all these facts and speculations about the market's future, the question that lingers the most among investors is that what should they do?

The first thing every investor needs to do is to stop pricing for perfections all over the world. Rather than believing that central banks can and will provide a stable floor for the market to stand upon, which is nothing but a perception, one should start planning for themselves and prepare accordingly for the worst to happen. Betting on Probable stories rather than Plausible ones makes much more sense, but sadly the reverse analogy is being followed (Take the case of Zomato)

Conclusion:

So rest assured, here are some key takeaways from my side with the hope of tapping the glorious opportunities which the future is going to throw at us:

Invest in the growth of the middle-class sector

If talking about the growth potential in India, the middle-class sector holds the key to its salvation. We are currently in a recovery phase from the devastating impact of covid on our economy. Hence, the earnings are bound to increase with time. So if we are considering the P/E ratio as a growth indicator, a market crash cannot be anticipated as the ratio will come down eventually without that happening.

  • Staying away

from overvalued and super inflated stocks like Titan (high P/E) and sectors (like pharma) of the market can make your investing journey a little safe and sound.
  • Hedge by buying Cryptocurrency

It is of believing that there is a good 10 to 15% population that believes in the Crypto narrative. To remove the uncertainties regarding the future of markets, investing around 20% of your portfolio in Crypto might be a sound hedging strategy. With the evolution and popularisation of Blockchain Technology (technology on which most Crypto operates) and its overtime infusion into mainstream tasks like Banking, Auditing, etc., speculations can be made about growth in this sector.

And what if the market crashes?

A likely scenario causing the market to crash in future is the Convergence of the Stock Market and the Bond Market talked above but guess what will this crash lead to; the boom in Crypto, which would make your hedge in Crypto successful.

Hence Investing in India and believing in its growth potential is the best bet one can make in the future.

Authored by Himanshu Sharma and assisted by Bhavy Dhawan
For any clarifications and suggestions reach us at info@manishanilgupta.com

Disclaimer!

This article is meant purely for knowledge and educational purposes. It contains only general information and references to legal content. It is not legal advice, and should not be treated as such

0 Comment

Leave a Comment


Blogs

Our Profile

In today’s business environment, the world demands quality professional services that are provided in a timely and cost-effective manner. We, at Manish Anil Gupta & Co, believe in putting our client’s needs squarely in front at all times.

Firm Profile Brochure

Download

Request a call back

"Need to know more about our services or what we do? Drop us your contact details and one of our professionals will call you to answer your query!"