The recent sharp rally in the market seems to have taken it back into expensive territory. Nifty's 12-month forward price-to-earnings or P/E ratio of 20.5 is close to the all-time high it hit in 2007.
The 50-stock index seems to be at an inflection point — a point where both earnings per share or EPS and P/E have converged. Historically, whenever this trend has played out, we have seen Nifty prices come down thereafter.
Back in December 2010, when Nifty's 12-month forward P/E of 14.80 times converged with forward EPS of Rs 336.87, we saw Nifty losing around 15 percent in the following two months.
In December 2008 too, a similar trend played out when the 12-month forward P/E of 12 times converged with forward EPS at Rs 291, we saw Nifty losing 8 percent in the two months that followed.
If the trend is anything to go by, Nifty could be looking at a correction.
A Bank of America Merill Lynch report suggests that markets could either fall in the near term or time correct. The report also suggests that the Goods and Services Tax rollout, which could further bring earnings uncertainty, may add to the pressure on the market.
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