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Is the stock market expensive and what should we do?

Global markets have had a dream run since March 2020 and that too in the midst of the worst pandemic in a century. India has outshone other global markets but is it expensive?

Are Indian stock markets overvalued?

As with everything there seems to be no consensus here. The answer depends on what tools are used to gauge the market.

  1. Buffett Indicator - Indian market cap to GDP ratio (one year forward) is at 111% compared to long term average of 103%. Even the US markets have crossed 200%, much higher than its long term trend.

  2. Price to Earnings ratio - Markets are trading at 21.8 times 12 month forward earnings basis, above the long term average of 18 times. Considering the pandemic, should we consider the last 12 months' earnings at all, some experts wonder!

  3. Price to Book ratio - ICICI Securities analysts believe the Nifty is currently trading at reasonable valuations on a PB basis. At 3.3x 12 month forward Nifty, the market is just above the long term average of 2.6x.

So is the market overvalued?

Investing is all about alternatives. If stocks are overvalued, what are you going to do? Low interest rates, and expensive real estate leaves us with few options.

So what should one do?

Investments have very little to do with Maths and more to do with Behaviours. We are always impulsive investing when the markets are rising and exiting when markets are falling! We should consider and plan for exits just like planning for entry into investing.

  1. Asset Rebalancing: This is the least understood and in my opinion, most important part of successful investing. Asset rebalancing forces you to "sell high" and "buy low" without worrying about market moves!! How does it work? Let's say you invested ₹100 a year ago and your defined asset allocation is 60% Equities and 40% Debt. Your Equity, with the 50% move, would have become ₹90 and your Debt with 5% yields would move to ₹42, taking your total assets to ₹132. Currently your Equity holdings form 68% (₹90/₹132). All you need to do is to shift 8% of your assets from Equity to Debt! Also remember to do the same when markets fall and debt forms a higher % of your portfolio. Do it once a year or when asset allocation targets exceed by 10%!

  2. Need the Money - If you are close to your goals, then you should consider redeeming. If you are planning to educate your child in 2023, and the corpus required has been met with this move in the markets, then you should move, in a planned manner, from volatile equity to safer instruments like debt. Debt may not yield much but a market correction shouldn't impact your child's education!! Again, don't wait till the goal is upon you but plan for it early.

  3. Profit Booking - Occasionally, there are exceptional gains in the markets. You might have done a tactical investment in an asset class or sectoral fund and that theme is running its course. This opportunity could then be use to redeploy the profits into existing investments.

Beware of the Abhimanyu factor. It isn't enough to know how to enter the maze of investing; a good investor also implements clear exit plans.

So next time, instead of asking "Is the market expensive" or "How much further will the market go up or crash", focus on the controllable - your goals and your asset allocation.

Source: Etmoney, Moneycontrol, Motilal Oswal

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