With the Sensex down near 24% from its peak, its worth looking at what the numbers have to say. Markets tend to peak when valuations are expensive, and animal spirits high. They tend to bottom when valuations are cheap, and animal spirits low. However, markets tend to become cheap only when recession risk is perceived as high. And I don't see recession risk as being high. I am happy to up my allocation to equity when animal spirits are very low, and have been low long enough to drive valuations down from expensive to neutral.  

The Sensex trades at 16.6X trailing 12 month earnings. That compares with a long-term average of 17.9 (median 17.3 times). This suggests that the market is at neutral valuations at 24,857, which is a good 8% over present levels. Relative to 3/2016 and 3/2017 earnings expectations, the market is already at neutral valuation levels, tending towards cheap. Thus, as of now, in my view, valuation remains at neutral levels, but tending towards cheap.

Cuts to earnings estimates have taken current year (3/2016) earnings expectations into neutral zone – there is now a better chance of a rise in current year expectations, than that of further cuts. 3/2017 earnings expectations are now well into neutral zone: the odds are for a rise or cut to forward earnings estimates are evenly balanced. My sense is that the next move will be stability to upward revisions in 3/2016 and 3/2017 estimates.  Earnings for Q3 FY16 have been mixed so far: I would look for the year (3/2016) to close with earnings of Rs 1,425 or better, compared with present consensus of Rs 1,395. 3/2017 consensus estimates are now at 1,625 and if the economic cycle in India does turn, I would look for no less than Rs 1,650.

A market devoid of exuberance would take the market to 27.4K in a year if 3/2017 delivers near 1.65K in earnings. That delivers a 19.2% return. And there is much upside to that: we could see earnings estimates rise, and should they rise, the market shall not remain devoid of exuberance. A level of 31K in 12 months would not surprise me.

With the Sensex at 22.9K animal spirits are now very low. Indeed, animal spirits are so low that a bounce in the coming week should be expected. I suspect we have seen a bottom, but whether it is THE bottom cannot be ascertained. 

The best time to buy is when animal spirits are low, and valuations cheap. Such events rarely occur. At present we have very low animal spirits, with neutral valuation levels tending towards cheap. The Sensex would be cheap at 21.2K, and very cheap at 18.5K. A cheap or very cheap market can be expected to arrive when an economy is in trouble: I’d say an environment where global GDP growth expectations are sub 2% levels. This, in my view, is not the case today: in fact, there is enough pessimism about, and that makes the case for optimism as the next move!  With that in mind, I believe the market has become as cheap as it ought to: we are seeing a buying opportunity which offers a five year forward return potential of 13% annualized, and a twelve month forward return potential of near 20%.

If you have confidence in consensus earnings estimates for 3/2017, now offers a decent opportunity to return to allocation – taking allocation to equity up to 63.6% (for an investor with 62.5% as the benchmark allocation to equity), might make sense.

India Allocation Data can be viewed here. Talking Numbers data for the Sensex can be viewed here - I'll warn you that very few people comprehend this data: not because its difficult - its just not very intuitive to a person who just happens glance at it.