On Stock Market

(source: Dilbert.com by Scott Adams)

It has always amazed me to see that how people can easily fall for the same error that they seem to correct at other times. The current writing is a consequence of an article I read recently in the last issue of DSIJ (Dalal Street Investment Journal) were in the editor-in-chief V.P. Padode said:

“Markets are poised in a such a way at this juncture that indexes may move sideways but there could be a lot of stock specific actions. We expect indexes to be in sideways trend for the coming couple of months at least while maintaining our targets for Sensex at 36000 levels by March 2018.

Giving targets works like placebo to the people to make them believe that they can measure the temperature with their tongues out even though scientifically that’s not possible. This reminded me of newspaper articles few years back making rounds at that time. I will go in ascending order year wise to make others understand how at different times widely followed and interviewed fund managers and CEO’s said and what happened in reality (or will happen). Taking a look at their predictions and analysing it will give us some answer to the predictive abilities of financial gurus even though there is none.

This news appeared in Business Standard on 5th June, 2014 (results of the general elections were declared on 16th May, 2014 in which BJP government won with wide margin) where Varun Goel, head of PMS, Karvy Stock Broking (there is something peculiar about names like these which makes us believe that the person behind the table must be knowing something, when in reality all he does is making people believe in something of which he isn’t sure of himself) predicted that Sensex could touch 100,000 by 2020. Another article on the same day in the same newspaper appeared wherein five reasons were given (I didn’t read them, not because I was overconfident that they would be worthless but because I was confident that, it just couldn’t happen)  as to why Sensex can touch 100,000 by 2020.

Here’s another one: On October 5th, 2015 an article appeared on Money Control  in which Utpal Seth, CEO of Rare Enterprises mentioned that Sensex can touch 50,000 by 2020. Many more can be mentioned but considering the effort and time, it would be a pointless exercise to mention them all.

Now let’s check what has happened since then and how much of that seemed plausible with the help of elementary mathematics in hindsight.

On the day of news article (first of the above) Sensex was at 25,019. To touch 100,000 within next five years, following needs to happen:

The market capitalization has to increase by 3.0517 times the market capitalization for the year 2015. The expert making this futile prediction also said that 3x is not very unlikely given that from 6,602.69 (2004) it reached 20,286.99 (2007) and went down to 9,647.31 (2009), then again touched 20,509.09 (2010) and reached 25,000 up until 2015.

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Market capitalization to GDP ratio is one the most tracked ratios to find out the valuation of the market. As a general rule a result of greater than 100% is said to show that the market is overvalued, while a value of around 50% is said to show undervaluation, not to mention that determining what percentage level is accurate in showing undervaluation and over valuation has been hotly debated. As per the projected valuations of 2015 the ratio came at 1.028 times of 2015 data. Below is the trend of the past:

chart1498457279769

For those who said that its very much possible that mark of 100,000 can be achieved didn’t have a good look at this chart or they were the victim of self-denial. They didn’t understood that the economy of a country doesn’t increase at such a rate that the market would increase 3 times within five years. We can see at the past trend to see what happens when it does. Looking at the chart it becomes clear that from 2004 until late 2007 was the phase of extreme bull period buoyant by the cheer of housing prices in the USA and (in the not-so-extreme sense) 10 years was over since the the economic reforms and it started to bear fruits ten years after (yes, reforms like that takes this much time to show its signs on economy), so the bull of privatisation that was unleashed in 1991 was at its full speed after 2000 (Sensex reached 20,286.99 from 3,972.12 within a period of 7 years, 5x within 7 years). After the fall of 2009, it more than doubled the next year and for the next five year it increased by 1000 points per year.

The bottom line is that: For Sensex to reach 100,000 by 2020 it needs to grow by 25% CAGR per annum. The so called financial gurus prophecies were/are wrong for two reasons:

  1. The data they were referring to were picked at the wrong point in the history’s time line. A period when everything seemed good and nothing could go wrong (remember Reliance Power, the big one).
  2. For the financial market to grow at 25% per annum, all the other metrics of the economy (GDP growth, Credit, Savings, Per Capita Income, Employment, etc…) also has to grow around that rate to support the financial system. Because stock market is like the mirror of the economy, it depends on economy not the otherwise. Think about it, when was the last time our economy grew at that rate (China did it at that rate for at least a quarter of century and see where it is, China’s GDP for 2015 was $10.87 trillion, around 10 times of India). The answer becomes clear when we ask very plausible question, can India become a $10 trillion economy in the next five years? Is it able to grow at the rate which can justify a market capitalization of 100,000 points? The answer is no.
  3. An increase in index 3-4 times within few years (100,000/25,000=4) is exactly the thing that takes the market at the extreme end of the pendulum and it’s reversion causes people to loose their patience.
  4. An analogy: An economy is like the company and indexes (BSE/NSE) are its price. There’s a fundamental rule of investment i.e, a security cannot be worth more than the asset underlying that security, the spread between the price and value will converge over a long period. The increased indexes cannot remain sustainable if the growth rate of the economy isn’t on par with the indexes.

The problem with people is that they make analysis based on the long history of the company, forecasting it long into the future, then taking short term decisions  based on price gyrations…..As Howard Marks said “ The problem is not of informational or analytical but psychological.”

The Present:

As of today Sensex is at the peak of 31,138 and Nifty at 9,574 both of which are at their near highs. If the discussion going round the news is to be believed, both of the indexes are touching the clouds and there is a paranoia in the market that it is nearing its correction while some believe that still some gas is left to push it further near 36,000 or 38 or 40. I never understood hoe people come up with numbers like this. I mean one can only give a range of something like that but not a specific number.

Before making any assumption about the crest and trough of the market we need to understand the reasons behind it. Much of the people rely on their instinct or media clutter on which I have little faith.

In my opinion the markets are rich but not extended to such a point where a correction or crash is eminent. I can’t say where the market is headed (up/down) but, I can come up with a satisfying conclusion for no-fall-yet in market based on some some numbers:

  1. For the past few months, on an average 4000+ crores of money are flowing in SIP’s every month. That’s approximately 48,000 crores.
  2. Since EPFO was given the liberty to invest in the equity markets more than 10,000 crores have been invested by it and there is a plan to invest 18,000 in the current fiscal adding fuel to the stock market that is already on fire.
  3. Increase in NPS schemes is also adding around 2,000 crores a year.
  4. At last, the retail investor who were siding on the sidelines till now will also jump on the bandwagon to get the benefit of rising fortunes. Not to forget that more people will come to senses that stock holding is better way to stay wisely wealthy.
  5. All of the above turns out around 70,000 crores in the current fiscal. Amount of this much when poured in the markets will eventually push the markets in the north.

At the end the only thing that can increase the chances of being correct is that; no matter what or where the stock market is, the only thing that matters is that you have purchased an undervalued company at such low price that it will go up in with time. The fall in market shouldn’t be the concern of investors and when it does, only to the point that it gives us more opportunity to buy of what we already know is good at reduced prices.

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