PE – Ratio a simple metric used to measure the valuation of the market. From the numbers one can understand whether the markets are cheap, expensive or fairly valued. Current PE Ratio Metric at 26.86 is little above the 2 standard deviation.
So how does it matters to a common investor? In simple statistical terms – Approximately 95% of the area of a normal distribution is within two standard deviations of the mean. i.e in simple terms 95% probability that Nifty is highly overvalued in normal distribution terms with mean reversion tendency is relatively high. Year 2000 and 2008 are the other periods where Nifty crossed 2 standard deviation where the end result is not a good outcome for the investors with short term or medium term horizon.
Nifty – PE Ratio Historical Charts
Img Source : Nifty PE Ratio
But one can still argue that markets are lognormal distributed rather than normal distribution. And often market shows a tendecy of “Irrational exuberance” i.e an overvalued market can remain overvalued for a prolong time without any logical reasons.
However Lets consider a what-if scenario. What if the markets are really gonna be overvalued? how well you are protected from any potential downside risk? Do you consider hedging your investment portfolio or planning to reduce your asset allocation in stocks and shift some portion of your money to different safer asset class? If your answer is yes then possibly you are a well mature inventor and willing to handle any kind of market situations.
Its not just about how much money you make in a bull market. It also matters how good you manage when there is a turbulence.
So this time will it be different or just the history gonna rhyme?