Equity markets are close to all-time highs and the question is whether markets are currently overvalued or not and if this is a good time to invest.
Markets in India tend to move in a 5 year cycle. Market valuations do play an important role in determining returns over the short term to medium term of 3-10 years. Thus investments made at lower valuations (lower P/E ratio, P/B ratio, Market cap/Sales) have yielded better returns if held for 3-10 years. Thus if you invest when the markets are down & trading at 10-15X trailing P/E band you can get 15-20% annualized returns over the next 3-10 years but if invested at above 20X trailing P/E band annualized returns tend to fall to single digits of 7-10%. These are market returns & certain mutual funds or stocks could perform better in the said time period.
For investments held for 15 years and above this tends to even out over multiple cycles & thus the impact of valuations on returns is minimal. Historically it has been seen that one can expect a 12-14% growth over such a period in line with real GDP growth in India. Incidentally GDP growth & Inflation in India always tends to add up to 12-14%. Mind you this is again just market/index returns & any investment in shares or mutual funds which beat market returns are expected to yield higher returns.
Trying to time the market for investing is a very difficult thing to do depending on the innumerable variables their movements tend to depend upon. The definition of over and undervaluation is subjective based on the valuation parameter used and can vary from time to time and from person to person (that is why you always have both a buyer & a seller at a price for a transaction to take place).
Thus instead of timing the market, investing for the long term through systematic investment plans (SIPs) is a better option. SIPs for longer tenures would ensure that investments are made across up and down market cycles thereby reducing the impact of market fluctuations. SIPs also inculcate discipline in savings & investing and avoids the endless debate on whether ‘this is the right time to invest’.
Sabyasachi Paul has been associated with equity research and advisory on equity markets in India for over 9 years & currently heads the equity research desk of Eastern Financiers Ltd, Kolkata.He also manages a portfolio on the online platform Kristal. Find link to the strategy named ‘The Tortoise’