Is it a good time to invest?
When the markets are high, people are concerned. When the markets are low, people are concerned. When is a good time to invest?
The equity market is driven by the share prices of various companies. But what moves the share price? Understanding this aspect can give us a better view of when to invest and what to invest in.
Father of value investing, Benjamin Graham says - "In the short run, a market is a voting machine but in the long run, it is a weighing machine."
In the short-term, mood of the market defines where the prices would be going. However, in the long-term, a company's performance defines the performance of the share price.
Can there be an analytical tool to assess the market mood?
Let us look at how you can assess the current mood of the market. This factor does not predict the future but focuses more on the present state i.e. whether the market is over or under-bought.
Factor = Earning yield + Dividend yield – 10 years government yield
A positive number indicates that the market is undervalued; else, you are better off in bond investing. At any point in time, the portfolio may be a maximum of 75% in equity and a minimum of 25% in equity.
Here are the investment rules you can apply:
1. Earning yield is reciprocal of current Price of Earning of NSE 500. If current PE is 30, earning yield would be 3.3%. (https://www.nseindia.com/products/content/equities/indices/historical_pepb.htm)
2. Dividend yield can be assumed as 1.50%.
3. Current 10-year government bond yield is 6.36% (https://www.bloomberg.com/quote/GIND10YR:IND)
The current factor based on September 2019 data is:
Factor = 3.5% + 1.5% - 6.7% = - 1.7%
If the factor is between -1% to +1%, a 50/50 combination of short-term debt funds and equity mutual funds is recommended. However, any other range may indicate allocation to equity as 25% (< -1%) or 75% (> +1%). Based on the current data, it's prudent to maintain 25% equity and 75% debt.
No one in the world can predict where the equity markets will go. However, smart investors always know that they can always manage their risk better and returns are generated over a while.
The consistency of return while managing portfolio risk is more important than high returns during bull-run.
This is a broad asset class level understanding between equity and debt. However, it can easily help any investor, even those who do not understand finance, make tactical asset allocation decisions.