Is it time to invest into PSU Banks?

Even though the markets are near to all time highs, one major sector that is lagging behind is PSU Banking Index. The chart below is a relative plot of Bank Nifty and CNX PSU Bank Index. While PSU Bank Index has been found lagging the Bank Nifty, the gap was never as wide as it is now.

But does that mean PSU Banks are cheap? The chart below plots the historical trailing PE of PSU Bank Nifty Index and a look at it does say that we are very near to valuations that were seen way back in 2009.

But the difference between Bank Nifty (where Private Sector Banks are now the main movers and shakers) and PSU Bank Index shows that the difference is not due to a fall in Banking stocks as a whole but a fall based on the perception of quality of assets and the returns one may achieve going forward.

A play on Banks is a play on the Indian Economy as well. If one believes that we have seen the worst and the economy should be rising from here onwards, a long on PSU Bank is the best bet since there does exist some “margin of safety” in terms of one buying them at a near historical cheap valuation. But on the other hand if economy is seen to deteriorate even further,  the best bet would be to be long Bank Nifty and short PSU Bank Index (though this trade cannot be set up due to non availability of PSU Bank futures).