Sensex @ 40,000 is Here!

“You’ve got to be careful if you don’t know where you’re going, ‘cause you might not get there.” ~ Yogi Berra

“The Golden Era Begins. Sensex target – 40000 by March 2017.”

This is not my prediction but one from a leading private sector bank’s investment advisory group. I received this report in my email yesterday, and haven’t stopped giggling reading the headline and the report’s conclusions again and again.

The author of the report states (emphasis mine)…

No no, we are not being very bullish, but are trying to value Sensex on the average multiple of 17x (which was seen in the previous bull run, the highest multiple being 25x 1 yr forward).

As per the Bloomberg consensus estimates the FY17 EPS stands at Rs 2000, we think that the FY18 earnings could grow at 20% for the larger companies if the GDP growth moves towards the 8%-9% mark. Hence, the FY18E EPS is projected at Rs.2400. At 17x FY18E EPS, we get a target of 40800 by March 2017, which we think could be a reasonable target to look for by the investors.

We think that the earnings growth would largely be led by the strong developmental focus of the new government and the multiple rerating would be primarily led by the under ownership of equities by the retail investors.

Sensex Nonsense is Back!
If you read Chapter 3 of Ben Graham’s The Intelligent Investor (which is one book you must read now, in these times of euphoria), the heart of Graham’s argument is that the intelligent investor must never forecast the future exclusively by extrapolating the past.

Unfortunately, that’s exactly the mistake people have made often in the past – whether it was the late 1990s, late 2007, or like we are starting to see now.

Jason Zweig wrote this in his commentary to Graham’s Chapter 3 of The Intelligent Investor…

A stream of bullish books followed Wharton finance pro­fessor Jeremy Siegel’s Stocks for the Long Run (1994)—culminating, in a wild crescendo, with James Glassman and Kevin Hassett’s Dow 36,000, David Elias’ Dow 40,000, and Charles Kadlec’s Dow 100,000 (all published in 1999). Forecasters argued that stocks had returned an annual average of 7% after inflation ever since 1802. Therefore, they concluded, that’s what investors should expect in the future.

Some bulls went further. Since stocks had “always” beaten bonds over any period of at least 30 years, stocks must be less risky than bonds or even cash in the bank. And if you can eliminate all the risk of owning stocks simply by hanging on to them long enough, then why quibble over how much you pay for them in the first place?

      
The Sensex @ 40,000 baloney that we are being fed now stinks of the same rot among financial forecasters that got them (and people who bought their predictions) into trouble several times in the past.

Believe me, this time it isn’t any different.

Is the stock market riskier today than 6-12 months ago because prices are higher? The answer is yes. It always has been. It always will be.

Graham warns…

Focusing on the market’s recent returns when they have been rosy will lead to a quite illogical and dangerous conclusion that equally marvellous results could be expected for common stocks in the future.

He adds…

By the rule of opposites, the more enthusiastic investors become about the stock market in the long run, the more certain they are to be proved wrong in the short run.

Thus, beware of this Sensex @ 40,000 nonsense! This has been repeated in the past as well, and you know what it resulted into.

The “Equity Under-Ownership” Joke
One rationale I hear for the Sensex @ 40,000 predictions floating around is that “equity is under owned by retail investors in India”, like what the above-mentioned report also states.

I agree with that statement because equity ownership in India constitutes just about 6% of the total household financial wealth, excluding real estate. This, when compared to the US levels of 45% is very low.

So yes, I agree that equity is under-owned in India compared to its potential as a long-term wealth creation tool.

But this “equity is under-owned and therefore stock markets will rise in the next 2-3 years as more retail investors invest” is a joke.

Ask the experts making such predictions why more individuals and households have not invested in the stock market in the past, and you can expect a blank stare.

The reason more individuals and households in India have stayed away from the stock market is because they have seen their near and dear ones (who ventured into the markets) suffer by way of bad financial advice.

They have seen their friends and relatives lose big time due to trading in and out of stocks, because they were forced by their expert advisors into doing so.

And if history is any proof, retail investors have always entered the stock market when the stock prices were at or near their peak – whether it was 1992, 1999, or 2007 – attracted by the shameless, salesy pitches of brokers and money managers – of “making quick money like others are doing”.

Be forewarned that such people – who are selling you the Sensex @ 40,000 and other similar junk – are out there to steal your wallet…and peace.

What to Expect?
I may be wrong here and the Sensex may actually reach 40,000 or similar such levels. After all, a 15-16% annual rise over the next 3 years will take it there.

A 14-15% growth in real corporate earnings plus a 1-2% dividend yield can cause this annual growth, which can take the index to its predicted number.

Now the big question is – can Indian companies grow their earnings at 14-15% over the next three years?

Of course an increase in infrastructure spending can lead to a higher GDP growth (the reason they have started selling you infra funds!), but this may not necessarily lead to higher corporate profits.

The reason – most Indian industries and companies suffer from excess capacity owing to weak demand in the past few years, and thus only a sharp rise in consumer and corporate demand can wipe out this excess capacity and bring higher profits to companies.

What is more, led by high inflation, a large number of Indian companies are suffering on the debt repayment front. So, they would require a sustainable increase in demand and operating profits to erase their sins from the past.

With inflation unlikely to decline and interest rates unlikely to fall in the near term, the 15% annual rise in corporate profits seems like a distant dream and not something that is easily achievable in the next three years, as the Sensex @ 40,000 predictors are claiming.

Not to forget the other demons like global issues, monsoons, and geopolitical tensions that can cause a lot of these flawless predictions to come to naught (but who cares about these anymore!).

You see, most of us believe we live in a predictable, controllable world, so we turn to authoritative-sounding people who promise to satisfy that need.

The reality is – We live in an unpredictable world. Predictions give us a false sense of security that causes us to take dumb risks.

Also, considering how calamitously wrong the “experts” were the last time they agreed on something, there is no way on Earth I or you should believe them now.

Taking a long term view, buying stocks of well-managed businesses at right prices is a great idea. But speculating in stocks just because someone said “stock market will zoom” or “Sensex will touch 40,000” is dangerous.

It always has been. It always will be.

Stage Four of Cocktail Party Stock Market Indicator?
I recently wrote a post on Peter Lynch’s Cocktail Party Stock Market Indicator. As I read that post again today, I realize that we have probably reached Stage Four.

The reason I say this is because, yesterday at my Investing Workshop in Mumbai, someone mentioned how he is getting stock tips from his office’s housekeeping guy.

In fact, I got a lot of tips from a few participants on stocks I should buy now. 🙂

It wasn’t a cocktail party but an investment workshop. But you still got my point, right?