I have written about the overall market a few times in the past (see here). The problem with market analysis is that it is fuzzy and not actionable. For example, if someone were to say that the market is undervalued, what does that mean and what should one do about it?

Most of the times, market analysis is just noise. Good to hear and entertain yourself, but not really actionable. That said, there are a few times when the overvall market levels can be analysed and some buy or sell decisions can be taken.

I have generally invested in the overall market via an ETF (exchange traded funds). An ETF can be bought or sold like a stock and esentially represents an underlying index (see here for more details).

I bought heavily (by my standards) in 2003-2004 and held the ETFs for 2-3 years. I started moving out by 2006 and was completely out by mid 2007. As I have written in the past, I have followed a very simplistic approach on investing in ETF’s : Buy when the PE is below 12 and start selling once it crosses 17-18.

There are several valid drawbacks of using this approach, such as
–        PE data is based on historical data. However the market is not stationary (which means that the index of year 2000 is not same as index of 2008), and hence the data is not comparable across time horizons
–        PE data is backward looking, whereas the returns will depend on what happens going forward.
–        There is no hard and fast rule that the market is undervalued below a PE of 12 and overvalued above 18. If the economy is going into a recession then a PE of 12 is not low as the earnings are about to fall off.

In spite of all the above drawbacks, I have found that buying below a PE of 11-12 and selling above 17-18 works well over a 2-3 year time frame. The returns are not fantastic, maybe a 40-50% returns over a 2-3 year time frame. However as it involves a minimal effort, I think it is worth it. The above approach may not give big returns, but it definitely gives better returns than a fixed deposit.

I have also uploaded an analysis of the market data – PE, P/B etc for the last 9 years (see file history data.xls in google groups). The data is downloaded from the nse website. As you can see from the data, the market has been below the current PE (11.9) only 2% of the days. I personally think that the odds are decent at the current market levels.

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