Bottomline | Market: Expect the unexpected

The eternal truth for anyone who has been in the market long enough is to know that no one knows where it is headed. Once you digest that truth, investing becomes a lot easier. So, let’s shut out the noise and see where we are perched today. We ran a basic check on historical valuations to get a sense of where we are and where we could go. Here goes.

We tracked valuations for the BSE-Sensex index using price-to-book value, as historical earnings can be less reliable, to find that we are currently at 3.7x in March and at 3.5x for the fiscal FY2024. While this isn’t cheap by any standards, the Sensex has traded nearly such annual valuations in 10 years since FY1999. In fact, in the three fiscals from FY2006 to FY2008, the Sensex traded well above 4x—5.5x in FY2008. Even in FY2010 and FY2011, the Sensex traded above FY2024 levels.

This suggests two possibilities. The first, if we enter a period of extreme exuberance, going well above 4x is a distinct possibility. On the other hand, if a big correction sets in, we could drop below the long-term mean and median of 3.2x and possibly even slip to below 3x. Given how things stand, at 3.7x, it makes sense to be wary but not unduly perturbed.

The price-to-book value for the BSE-500 for FY2024 Is at 3.4x, which was surpassed in the similar periods as the Sensex, but the gap is slimmer than for the benchmark index. This suggests that valuation levels for the BSE-500 are more elevated than for the Sensex. What’s more important to note is that the multiple in March of 3.74x is much higher than the long-term median and mean of 2.9x and 2.7, respectively.

Since the BSE-500 is a very broad index, you will likely have a mix of sections of froth and fair or undervaluation.

So, you need to be picky about where you put your money. That said, the index gives a sense that the market in a broader sense is at a vulnerable position. So, be alert and watchful of a possible correction.

Small caps are clearly trading at elevated levels when compared to historical levels—though the limited data series restricts the accuracy of this reading. For FY2024, the price-to-book value at 2.9x is well above the seven-year mean and median of 2.2x and 2.3x. What’s more, the reading in March is 3.1x. This does suggest that there can be greater risk of price correction in this section of the market. SEBI’s concern around liquidity of small cap mutual fund schemes is therefore not unwarranted.

A segment of the market that has been drawing a lot of attention of late is the stocks of public sector companies. We dipped in to check if signs of froth were emerging in this pocket. Surprisingly, we found that there is no such reason for concern at the moment. The price-to-book value for the BSE PSU index in FY2024 is 1.5x in-line with the long-term mean and median of 1.5x and 1.4x. Also, the reading for March at 1.98x, though high, is well below the multiple between fiscals 2007 to 2012. So, if this indeed is a bull phase for PSUs, there could be more gains in store, though a correction from 1.98x in the short-term cannot be ruled out.

In a nutshell, the market is clearly expensive at a broad level. That said, there is relative valuation comfort in large caps and growing risks in small caps. PSUs are not unusually expensive despite the sharp run-up, but there can be pockets of froth within the segment.

In such a market, you need to be doubly careful about where you invest. Valuation comfort is your friend, even if the tide turns. And be wary of rocketing small caps—where greed can get the better of good sense. Remember Warren Buffett’s oft repeated line: “Be fearful when others are greedy, and be greedy when others are fearful.”