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Nifty 50 Valuation hits all time high! What does this mean for your portfolio?

 

The month of August,2020 witnessed the Nifty 50 index Price-to-Earnings (PE) multiple reaching an all-time high of 31.64 times its trailing 12-month earnings per share (EPS).The last time the Nifty PE reached its all time high of 29.9x was in June 2019.

The market reactions during the Global financial crisis in 2008 is a bit different from the current scenario because it was essentially a banking crisis which was then cushioned by extensive quantitative easing by the central banks that was followed everywhere.

Here, the level of precariousness is much higher because every segment of the economy has been hit hard with a breakdown of all economic activity and the return to normalcy at this point is ambiguous.

Also, the interest rates during the 2008 Financial crisis were much higher and the global economy was on an upward trend whereas currently, interest rates are lower and the economic cycle had started to submerge even before the pandemic struck.

What does this mean?

In times of an economic crisis like the one we’re in, investors, especially retail investors, flock to a more safe and conservative approach where the Flight to Safety tends to bid up share prices which in turn inflates the valuation metrics substantially. Safety is thus perceived mainly as Large cap stocks which are considered less volatile and less riskier as compared to Mid and Small Cap stocks due to the financial stability of such companies.

As illustrated below, the top 5 companies in the Nifty Index as of July 31st,2020, account for more than 43% of the total Nifty Market Capitalization.

Top 15 Nifty Companies as of July,2020

Hence, the current valuations seem extremely high and irrational from an earnings point of view and may not be sustainable unless an unanticipated Covid vaccine hits the market in the next few weeks coupled with an economic upturn which triggers a strong earnings growth in FY 2021.  

What should be your Portfolio response?

Given the earnings surprises and the unprecedented support from global central banks, equity markets are slowly gaining momentum. The RBI, on 01st September,2020,  announced additional open market operations worth ₹20,000 crore and term repo operations worth ₹1 trillion to infuse liquidity into the market. In order to reduce the cost of funds for banks, it also allowed them to swap the funds raised under long term repo operations (LTRO) at 5.15% with new funds made available under the ₹1 trillion repo window at 4%.

These factors combined with a low interest rate environment is likely to keep the valuation elevated, especially for resilient companies which illustrate quality of earnings, sustainability of growth prospects and possess fundamental moat, which are some factors that you should consider while picking out the right gems for your basket of portfolio.

As always in case of any queries or to improve the quality of your portfolio, we are here to help you!

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