Nifty Performance vs. PE Ratio

One of the key numbers I look at regularly is the PE ratio of Nifty to have a idea as to the valuation Nifty currently commands and whether markets are cheap, expensive or neither of the two.

For quite some time now (since mid 2011 to be precise), Nifty PE ratio has been moving around its long term average. Only once did we see a major dip which brought the PE to its 1 Standard Deviation on the lower side. 

As on date, the current rise has meant that we are closing in on the 1 Standard Deviation on the upper band though even that is bit far away. But what is interesting is how does the PE compare to the return of Nifty.

Since 2008 low, Nifty has appreciated by 150%, Nifty PE has appreciated by just 85%. But more interesting is the way this has been accomplished. Lets first take a look at the chart;

After the markets bottomed out around October 2008, we witnessed a steady recovery post the bottoming of the Dow in March 2009. But even as the markets were dipping in the first couple of months of 2009, PE was already starting to move higher indicating the impact of bad results which were pushing up the valuation of Nifty even as Nifty itself did nothing.

This can be seen till the early part of 2011. Nifty doubled from the lows, the PE out performed it (in essence markets became pretty expensive in a very short span of time). To get a handle on how expensive Nifty was, do note that the high point was above the 2 standard deviation (which was seen earlier in 2008). 

But from that point on wards, things have changed tremendously. Markets started to outperform the valuations (in other words, even as markets went up, quality of earnings meant that valuation wise, markets were still cheap). 

I believe that unless we have another major global meltdown, this gap will only increase further. In hind-sight, markets seem to have been a buy on dips since early 2011. Question though is, is that strategy still a valid one? I for one believe so.