Valuation and Outlook for Indian Markets

The Indian stock markets (S&P CNX Nifty) has gone up 93.4% from its 9th March 2009 lows of 2573.15. This is one of the best returns the Indian indices have given in a six month time frame. This article tries to figure out how much more upside the current rally has and if it's advisable for investors to consider exposure even at these levels.

I mentioned in the beginning about the 93.4% surge in the markets since 9th March 2009. However, if we break up this rally into equal parts then the following is observed:

1. The Nifty went up 80.9% from 9th March 2009 to 10th June 2009 (3 month period). On 10th June the Nifty closed at 4655.25 as against a low of 2573.15 in March.
2. The Nifty has gone up 6.9% from 10th June 2009 to 18th September 2009 (3 month period). On 18th September the Nifty closed at 4976.05 (new highs for the year) as against levels of 4655.25 in June.

So, in the last three months, the Nifty has practically gone no where. The markets have been largely rangebound with a slight positive bias (which is indicated by the marginal rise in the Nifty post June 2009).

In my opinion, the best part of the current rally was over in June and after a 7% rise post June 2009, the Indian markets are headed for the correction in the next 2-3 months. My opinion is based on some fundamental and technical factors which I would discuss below.

Price Earnings Ratio for the Nifty

The historical and current PE for the Nifty gives some insight into how undervalued or overvalued the markets are currently. Below is the PE valuation graph for the Nifty from 9th March 2009 to 18th September 2009.

Data Source: National Stock Exchange

As shown in the graph above, the Nifty PE has gone up from 12.2 in March 2009 to 22.4 currently. These are expensive valuations considering the fact that the world is now just getting hopeful about coming out of the worst financial crisis and one of the worst economic crisis.

Also, the following needs to be considered:

In the last nine years, the Nifty PE has never gone above 28.5. The Nifty commanded this PE during times of extreme optimism and during the peak of liquidity cycles. Thus, the current PE of 23 again looks expensive relative to historical data. The markets are also giving the same indications and has hardly made any significant moves in the last three months. So at times, one needs to listen to what the markets say, and currently the mood of the markets is not very bullish.

Movement of the Dollar Index

I have explained in some of my previous posts the simple relation between the Dollar and Equities. It is as follows: When the Dollar goes up (an indication of tightening liquidity), the Equities and Commodities fall and when the Dollar goes down (indication of excess liquidity), the Equities and Commodities surge higher.

Recently, when some of the major global markets (including India) touched new highs for 2009, the Dollar touched new lows for 2009. Thus, it is very important to look at the Dollar index for any trend reversal.

Chart Source: Bloomberg

As evident from the chart above, the Dollar Index has gone down from a high of 85.9 in March 2009 to a new low for the year (76.2) on the 17th of September 2009. What I wish to emphasize is that the sentiment on the Dollar is very bearish right now. The number of traders betting on the Dollar going down is well over 90%. Generally, when trends get so bearish, there is a sharp counter trend which gets established and even a slight upmove in the index would lead to traders covering their shorts (which would lead to further rally).

Thus, in my opinion, the Dollar is very oversold in the near term and might make a temporary reversal in the next 2-3 months. This would be negative for equities and commodities and hence these asset classes might trend down over the next 2-3 months.

Nifty Trading 23% above its 200 Day EMA

The Indian markets are currently trading 23% above its 200 day EMA of 4055.69. This is very important in the context of valuation of the markets. It must be noted that if the markets are trading above their 200 day EMA then it is a bullish indicator. However, whenever markets have gone way above their EMA's, there has been a trend reversal.

Chart Source: Yahoo Finance

The chart above shows the Nifty movement and its 200 Day EMA for the last one year. I consider the trading of the Nifty 23% above its EMA important and a sign of an impending reversal based on the historical Nifty and EMA trend.

When the markets peaked out on 9th January 2008, the Nifty was trading 25.3% above its 200 day EMA. Similarly, when the markets corrected significantly in May 2006, the Nifty was trading 26.5% above its 200 day EMA. So whenever the markets trade more then 23-26% of their 200 day EMA's a sharp correction follows.

The following is another interesting piece of data: In March 2009, when markets made new lows, the Nifty was trading 26% below its 200 day EMA. Currently, the trend has reversed and the markets are 23% above its 200 day EMA.

So the EMA indicator also points to overvalued markets in the near term.

High Valuation of Nifty Stocks

As on 18th September 2009, 52% of Nifty Index stocks are trading 40% above their 200-day simple moving average. This again is an indicator of overvaluation in the near term.

There are three stocks in the index which are trading at over 100% of their 200 day SMA. These stocks are:

1. HCL Tech - Trading at 101.7% above 200-day SMA
2. Jindal Steel - Trading at 106.6% above 200-day SMA
3. Tata Motors (TTM) - Trading at 118.3% above 200-day SMA

Thus, while picking stocks even for near term, these counters can be avoided for now.

Conclusion

As per the charts and valuation discussed above, the Indian markets surely are in overbought zone in the near term. My expectation is that the markets will correct significantly over the next 2-3 months. I personally would avoid taking any long positions at current valuations.

I can also say with some conviction that we are not going to re-test the March 2009 lows in the near future. So any correction can be a good opportunity to consider exposure to quality stocks. It is always difficult to predict market movements and time the markets. But if an investor buys quality stocks and has the patience to hold on to his positions for long term then big gains can be expected.

The best part of the India growth story is still to come and the same would apply to the Indian Stock Markets.

Disclosure: No Positions in Stocks Mentioned in the Article

Comments

[himlynx:]

Excellent article. Thank you.

Sep 21 12:41 PM

[Mad Hedge F...:]

nzx India has been one of my stellar picks this year, the “I” in BRIC, rocketing 112% from the March lows (click here for my initial report ). Although it appears overheated for the short term, I believe it has much further to run over the long haul. You want to buy countries that have yet to build infrastructure and a middle class, and China has already done that. India’s per capita GDP came in at a sparse $1,016 last year, compared to $6,100 for the Middle Kingdom. China’s economy today is about on the same level that Japan experienced during the late fifties, while India is still in the late twenties, with large parts effectively mired in the 16th century. India’s recent election of a more pro-business government was the trigger for improved growth, which is expected to exceed 6% for the rest of the year. India’s economy is entirely domestic, and is so far outside the world economic system that the global financial crisis was barely felt there. While we were melting down with a minus 6% GDP rate, India continued to bask in a plus 5.8% growth rate. No subprime debt, toxic portfolios, foreclosure crisis, government bailouts, or AIG, GM, or Chrysler. With 1.2 billion consumers, some 70% of GDP there accounted for by consumer spending, so retail figures large in the country’s future. Even Harley Davidson (HOG) has big expansion plans in the world’s largest user of motorcycles. For those of the ETF persuasion, look at Wisdom tree’s earnings based offering (EPI) or the one from PowerShares (PIN). Better start checking your share prices in rupees.

Sep 21 11:46 PM

[Pratik Shah:]

Only thing which can break this rally is the negative earnings surprise. And any fall in the market is a huge buying opportunity. If you look at the fund managers in India most of them are still sitting on ample of cash. In last 6 months, post election there have been small opportunities for investors to enter for long positions, but never a big one.

Sep 23 01:08 AM

[NikB:]

yawn

Sep 24 08:02 AM