The Relation between P/E and Interest Rate.

 You all might have read the announcement by various rating agencies like Moody's and S&P or any other that the Indian stock market is in an overvaluation state and apart from all the talks and things we all kind of agree with it has risen too much to even justify by earnings or other factors. So what could be the cause of this, we can argue there are a lot of new retail investors who are investing in keeping the market going up but in India, Institutional is the big player even in DII's, FII's are a whole different story. 

So what could be other justification for this, too much money revolving around this one sounds correct but the question is by how much and by what, to answer this we can look at Yields on Bonds. But why Yield of bonds, the answer to that is assuming there is X amount of money in the world with let's say 4 asset classes where this money can go like Bonds, Equity, Real Estate, and Gold. Now if due to some reasons the bond class is giving less returns than it should have that money allocated to is going to flow to some other source which gives it high returns, think of it like 4 water tanks are connected now if the water in the tank goes high it needs to flow to other tanks to level itself (I will try to attach an illustration made by me hope its good). Now the Money has flowed from bonds to equity which is in discount after the crash the money mostly went here, the real estate also went overvalued soon with gold coming with it. 

SO look at the above information and combine it you have multiple sources of returns and the money kept flowing to the one which provided it the highest returns sounds logical there, so that answers our question 2.

Now coming to question 1 by how much, to answer this I pulled some data from Bloomberg and made a nice line chart to make it easy to understand, so the answer is in the movement of the bond yield and the market p/e, I have used 1-year yield cause that was the only available for 5 years in Bloomberg and also as it is highly liquid. The chart shows an inverse movement between the Yield and Market P/E. So when the yield goes up which means the money is going away out of the market and your P/E also drops. But when the yield drops indicating new money introduced in the market and low return from Bonds so that money goes to the equity side of the market.

The movement is something I found interesting in this case, it's an inverse movement which makes things a lot more clear and this could also be a guiding stone to forecast the market situation based on your Central Bank moves for the coming months.

As always if you are reading it till here thank you for reading this and if you want the excel file please message me and I will share it, there could be more posts regarding the same topic of the other markets.

The adventure of 2 asset portfolio and correlation!!!!

 Hello guys, 

A quick project I made well I just learned about it too so why not make and share it!!

So it's about the Markowitz portfolio theory, you can search about it on a book or google. I'm not explaining here..

So to make a portfolio from 2 assets the correlation affects the risk that would come up from the entire portfolio, if a portfolio is highly correlated then the risk obviously goes up kinda like leveraging. If the correlation is low then we get diversification benefit from it, and if the correlation is negative the Voila you have reduced the risk more than the individual assets you increase the weight or exposure you get more diversification.

So I wanted to just see how this looks in real life other than book diagrams so I made them. I used my asset correlation matrix to select asset classes.

Positive Correlation Near perfect correlation:-

I wanted to use Nifty IT and Nifty as the correlation is .95 but I didn't get enough data on it so I choose a nifty and nifty bank, I took the returns, and SD calculated the portfolio risk and plotted it. The returns are so high and nice here as I didn't actually earlier knew the timeline to pick so I took 10 years monthly returns so these returns are normal over a 10 year period.

So you can see the line is just a straight line which shows in this portfolio as you increase your portfolio weight in this to more risk you get rewarded with higher returns. I have not added any risk-free asset cause you know why..

Now moving on so now a challenge for anyone who has read it till here, I couldn't find an asset with a negative correlation other than currencies and I guess the FTSE index might do the trick there too, but if you find an asset with a negative correlation please do tell me.

Now actually moving on to assets with a low correlation like normal assets do, so I have here NIFTY and TCS to demonstrate, a bit of change here I took 5 years' monthly returns cause I wanted to explain a bit more here. So the return and SD of NIFTY are 33% and 5.31%, TCS return and SD are 43% and 7.16%. The correlation of both assets was .49 so not a perfect correlation. So I did all the excel work like earlier and plotted it in a graph to get the Efficient frontier. 

So here it is, our Global minimum variance portfolio is observed at a return of 35.05% with an SD of 5.114% so yay we achieved diversification, now I need to make the optimal portfolio which depends on utility and other factors so I'm not taking utility here, the theory assumes borrowing and lending happen at the same rate but DOES IT!!!! so as the deposit rates are too low so I'm taking lending rates and for that, I used the most common type of loan an individual can take for doing this and which was personal loans at 24% this is an actual rate take from a bank. by using that I made the tangent line from which touches the point of our optimal portfolio with a return of 35.99% and portfolio risk of 5.137%. 

From this what I got is the portfolio offers diversification, correlation matter, and you can make a sweet high yield portfolio with lower risk very easily. 

I do want to make a portfolio that not only takes 2 assets but takes the entire universe its a very big project for sure but also fun, and that's why we do this too.

So there it is my small project which took  2 weeks to make and few more days to publish, I will see you later meanwhile I hope your returns are high and your volatility is low, and keep hunting for wild things in this market. Goodbye.