Is the Nifty Sounding the Warning Bell for a Crash?

Mar 26, 2021

Editor's note: I wrote this piece in November 2020. I warned you about the risks in the market. I also told you the Nifty could keep going higher before a crash. That is exactly what happened. The market kept going up and now it has started to fall. I believe the investing lesson in this piece is more relevant than ever. Read on...


Rahul Shah, Editor, Profit Hunter

The benchmark index Nifty achieved a noteworthy milestone a couple of weeks back.

Its PE ratio touched an all-time high of 34.9x.

This means that investors are now willing to pay Rs 34.9 for every 1 Re earnings earned by the index.

How expensive is that?

Well, it's almost 75% higher than the long-term average PE of around 20x. It's like buying a stock valued at Rs 100 on average, at Rs 175.

This makes the benchmark index not just overvalued but significantly overvalued in my view.

Thus, if the index is at an all-time high PE and is significantly overvalued, then shouldn't you be worried about a stock market crash?

Shouldn't you consider moving out of stocks?

Hmmm...these are logical arguments and make a lot of sense.

However, here's the thing.

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An index reaching an all-time high PE doesn't mean it can't go higher and achieve still higher PEs.

Here's some for perspective...

The BSE Sensex, another benchmark index and one with a longer history than the Nifty, had once peaked at a PE of close to 50x.

Yes, that's right. 50 times its earnings.

There's no reason why the Nifty can't reach those levels before coming crashing down.

Thus, if you sell all your stocks now and the index keeps going higher, you will miss out on the gains.

However, you also need to protect your portfolio against a big stock market crash the possibility of which is higher now than back in March.

It's an interesting dilemma, isn't it? To sell or not to sell.

A lot of investors I know don't worry about a crash at all and stay 100% invested all the time.

They believe that since the stock in the long-term is all about higher highs and higher lows, it doesn't make any sense to stay out of it.

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Then there are others who may not hesitate to sell all their stocks and move back into the market only after a sharp correction of 30% or more.

As far as I am concerned, I believe in the following lines from Ben Graham's classic The Intelligent Investor.

  • It is the mark of an educated mind to expect that amount of exactness which the nature of the particular subject admits.

Put differently, precision has no place in the field of investing.

In investing, it is always better to be approximately right than precisely wrong.

Trying to be precise would mean being convinced about a crash or a big bull run and positioning your portfolio accordingly.

However, if the market went in exactly the opposite direction to your precise prediction, you could receive a big setback.

This is why I always try to be approximately right.

If I have Rs 100 with me, I put Rs 25 each in stocks and fixed deposits/bonds. I will then decide on the remaining Rs 50 based on the broader market conditions.

If the markets are attractively priced like they were in March/April 2020, I will put the remaining Rs 50 in stocks and thus have stock: bond exposure of 75:25.

If the markets are expensive like they are now, I can shift the exposure to 50:50 or even 25:75 in favour of bonds.

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Right now, since the Nifty PE is at an all-time high, I have preferred an exposure of 50:50 in my penny stock recommendation service - Exponential Profits.

The service was 75% invested in stocks till a few weeks back. However, as the markets kept going up and the index PE inched higher, I changed the division and recommended my subscribers to go 50:50.

Of course, a case can be made to be only 25% invested in stocks and 75% in bonds instead of 50:50.

This is also perfectly fine in my view.

As long as you are minimum 25% in each asset class, you can decide the remaining allocation based on your individual risk profile, your goals, and the confidence you have in your own research.

Please note that as a value investor, you should never try to profit from market fluctuations.

Your primary interest should be to put more money to work in stocks when the market falls and take some money off the table when it rises.

I believe my strategy does just that.

And that is why I like it so much. It is simple and yet highly effective.

It also doesn't force you to bite you nails over which way the markets will move next. You already have an actionable investing plan ready for whatever Mr Market throws your way.

Warm regards,

Rahul Shah
Rahul Shah
Editor and Research Analyst, Profit Hunter

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