S&P-500 is up.
Sensex, Nifty and Mid-caps are up too.
The general feeling appears to be great when markets are rising, indicating some kind of a bull run. However, optimism has a cost as well; over-optimism in conjunction with hubris surely has. When emotions flow without restraint something goes wrong; invariably so when it comes to the financial markets. These markets do not understand human emotions, greed or fear, hubris or any other. Lest the costs become heavy, it is wise to keep a cool head, feet on ground, and emotions in check under all conditions.
These thoughts alright; the question is whether these markets are exhibiting any folly today. Nifty is currently trading at its all time high of 6736.10, with a PE ratio of 18.95, PB ratio of 3.25, and a dividend yield of 1.37%. Sure, it has seen much higher PE and PB ratios, and much lower dividend yields in the past. That does give some comfort, but not much.
There is another way to check whether Nifty is too high or not. Implied equity risk premium in the market price should tell us something about where the market is headed. It may still not be fully conclusive though. Since the dividend yields on the Indian markets have been too low, implied variables resulting from dividend discount model would not be that appropriate. Instead, free cash flows to equity based valuation should make sense. Earnings growth rate is assumed to be same as dividends growth rate which is alright since dividends usually follow earnings. Implied dividends growth rate, and then implied equity risk premium are calculated from the current market values.
The long-term government bond rate of 8.81% adjusted for default risk is used as a proxy for risk-free rate. Currently, Nifty has return on equity of 17.15% and dividend payout ratio of 25.96% which are not too far away from the long term average values.
Equity risk premium supplies some clue about the direction of the market; higher premium suggests that market is undervalued, and vice versa.
Based on the current market values of Nifty the implied equity risk premium is estimated at about 4.08%; with a historical average of 5-5.50%, it appears that Nifty is a bit overvalued.
It is a bit of fun to check out the equity risk premium values implied in the historical market values of Nifty.
The exercise is more out of curiosity than anything else. It tells something though...for those who are looking for clues. Are the markets heading towards a bubble, or not yet?
We are not near that dot-com bubble of 2000 yet might give some solace. Let's not make too much out of these, nevertheless.
The folly is always with us, never with the markets. Time to make detour with caution, I reckon.
These thoughts alright; the question is whether these markets are exhibiting any folly today. Nifty is currently trading at its all time high of 6736.10, with a PE ratio of 18.95, PB ratio of 3.25, and a dividend yield of 1.37%. Sure, it has seen much higher PE and PB ratios, and much lower dividend yields in the past. That does give some comfort, but not much.
There is another way to check whether Nifty is too high or not. Implied equity risk premium in the market price should tell us something about where the market is headed. It may still not be fully conclusive though. Since the dividend yields on the Indian markets have been too low, implied variables resulting from dividend discount model would not be that appropriate. Instead, free cash flows to equity based valuation should make sense. Earnings growth rate is assumed to be same as dividends growth rate which is alright since dividends usually follow earnings. Implied dividends growth rate, and then implied equity risk premium are calculated from the current market values.
The long-term government bond rate of 8.81% adjusted for default risk is used as a proxy for risk-free rate. Currently, Nifty has return on equity of 17.15% and dividend payout ratio of 25.96% which are not too far away from the long term average values.
Equity risk premium supplies some clue about the direction of the market; higher premium suggests that market is undervalued, and vice versa.
Based on the current market values of Nifty the implied equity risk premium is estimated at about 4.08%; with a historical average of 5-5.50%, it appears that Nifty is a bit overvalued.
It is a bit of fun to check out the equity risk premium values implied in the historical market values of Nifty.
The exercise is more out of curiosity than anything else. It tells something though...for those who are looking for clues. Are the markets heading towards a bubble, or not yet?
We are not near that dot-com bubble of 2000 yet might give some solace. Let's not make too much out of these, nevertheless.
The folly is always with us, never with the markets. Time to make detour with caution, I reckon.
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