In the past 15 years, the Nifty PE has ranged from around 11.2 (2003) to 27.1 (2000). Even at the height of the bull market we hit a PE of 26.5 (Dec 2007) while at the depths of 2008 decline we hit 12.4 (Nov 2008). We are currently around 18 to 19 levels.
Obviously with such variances in PE the returns from the market will also vary quite considerably. We have a fixed way of looking at markets and valuations and often one hears statements that the market is over or fairly or undervalued. It is difficult to know on what basis someone is saying this. Are they using historical highs and lows to say this or are they using averages? While averages are good to give us an idea they also mislead you into some wrong conclusions. For e.g. it is considered “safe” to buy the market when the PE is around 15 or below and unwise to do so when PE is above 24. Having been part of markets for almost four decades now, I disbelieve such statements of generalities. Returns in the market are a function of when you entered it and how long you stayed in. A simple look at the variance between the highs and lows of returns over a three year period (as a reasonable “long term” time frame applicable to most people) should help us understand this better. Across the past 15 years, if one checked the data the 3 year return would show the following figures.
|PE Level||Max Return||Min Return||Avg Return|
|16 to 20||45||-10||13|
|20 to 24||32||-14||4|
It can be seen that the variation is extreme. Depending on when you entered the market- at any of the PE levels- your return could be a very good number or a very poor number! This is true whether you entered the market when it was deemed cheap (below 15 PE) or expensive (above 20). In both cases you could still end up making very good returns of 30% plus or do a miserable negative return! The situation is very similar if you were to extend this to beyond 3 year returns as well.
While everyone considers PE to be a fundamental variable, a closer look at it will reveal that it is also a technical variable (since it has computations based on price). More, looking at the variation of the returns, it is obvious that using PE ratio alone won’t make a difference to your returns. It will have everything to do with the timing of your entry and exit from the market that makes a difference to your returns! As can be seen from the table, if you invested in the market during the times of high PE (20 to 24) but did so cleverly, you could still have had an astounding 32% as your 3-year return! But if you used the PE levels and got in around 15 or lower – thinking it to be safe- but you did so at the wrong times, you may still have come off with negative returns!! So much for cheap and expensive valuations!!
Looking at the data from a different angle, one finds that the number of months that the market spends in these PE windows is not too different. In the period of 2000-2016 (a period of 192 months), the market spent 50 months in PE under 15, 73 months in the PE range of 16-20, 59 months in the PE range of 20-24 and only 10 months above PE of 24. If the major portion of the time the market spends in the PE range of 16 thru 24 (total of 132 months out of 192 i.e. 69% of the time) and max returns in that zone have ranged from 45 to 32%, then it is obvious that this is the area we must concentrate on! It is nice to say that we must buy cheap but market spends less than 25% of the time being cheap! We have to worry even less about the high PE because the market spends only 5% of the time being expensive!! Another interesting finding when you look at the time spent in the different buckets that I have classified the PE into, is that the market moves very quickly into the 15-20 range after the trends hit the skids (either cheap or expensive ranges). In fact, examining the time window of the last 15 years, if we look at the truly bullish years, we will find that the PE generally tends to remain in the 15-20 range most of the time. Ever since the middle of 2009, the PE has been maintaining this range right till now! In 2015, price expansion occurred but earnings expansion did not happen and hence the PE moved to over 23 times. That is now being reset with a price decline bringing the PER to around 18 levels by now.
So, all those who say that you can’t time the market, the returns table should be sufficient evidence that you do need to time the market! Now, it is an entirely different matter that many people do not know how to time the market. In that sense I would agree with the statement that one should not time the market. You cannot do what you don’t know!!
But help is available all around. There are hundreds of people teaching you technical analysis that has all to do with timing the market. If people don’t take the effort to learn what is available to them quite easily, well, then whose fault is it? One should not then complain about the returns that you generate! In fact, one can go so far as saying that, in all probability, much of the better returns that you generated actually occurred thru luck!! It should be obvious from the table that the right combination of reading the market status along with the ability to time it well will help us to garner returns that are far superior to what one can obtain thru SIPs or random investing or plain buy and hold and hoping for the best. Market does not reward laziness. People many times substitute laziness with long term investing!
The data that we have looked at now says that PE is currently kicking back into its main range (16-20) where it spends majority of its life. If we bring a timing element into our trades now we should be able to get stocks at levels so as to generate a decent 3 year return. Can it go down some more and the PER become even more attractive a level? That is possible. The 2013 average PE was about 17.75 with only two months showing below that average (median is 17.85). Based on Nifty trailing earnings at 385, we would go to 17x at around 6600. Given that we have not traded below 17x ever since mid-2009, it seems fair to think of any dip into that zone as a good opportunity to begin timing the market.