16000. The figure invokes a very strong sense of déjà vu. We’ve been at 16000 once in 2007, thrice in 2008, twice in 2009, twice in 2010 and four times in 2011. The level has acted as a support for the market many times, most notably in 2010 when the market rebounded sharply both times it hit 16000. Support is the technical term but what it really means that the market found enough suckers to buy the market at that level. Someone who bought into the Sensex at 16000 in 2007 has made no money for more than four and a half years. This level is almost 25% below the Sensex life high of 21000. At such high levels, the logic which is sold to investors for long term investment is that one should not look at the trailing twelve month P/E but the forward P/E. The forward P/E projection is usually 20-25% higher which is used to imply 20-25% growth in value of the index.
Going by this logic, an investor should have got 20% returns YoY since 2007 instead of zero or negative. Why has this not happened?
EPS: an analyst joke
Ignoring market gyrations, I will simply state the most basic reason. The Sensex has been overvalued for the past several years. EPS growth has never been even close to the levels predicted by analysts. In Jan 2008, Citigroup said that the Sensex at 21000 was trading at 22 times forward P/E. Thus they were predicting a Sensex EPS of 955 for FY09 (by the way, they had a Sensex target of 23950-25000 for the year.) Even 1000+ estimates were made by some. The actual EPS after twelve months was 792. The funny part is that the figure of 955 is the current EPS of the Sensex according to bseindia.com(13 January 2012 with Sensex closing value of 16154.62 and TTM P/E of 16.91. The data from NSE suggests a higher Sensex EPS for the twelve months ended Sept 2011 at Rs.1013. Citigroup like many other analysts had projected extreme bull run conditions into the future. This is a recurrent phenomenon which has been seen this year as well. Bloomberg consensus estimates for Sensex FY12 EPS were at around 1250. I would be surprised if it achieves 1050.
Conflict of interests
These consistent overvaluations are not a mistake but part of a very concerted plan to lure gullible investors who are stupid enough to believe in ‘finance experts’. The models of these experts are so complex and they consider so much data that they give themselves and investors the illusion of actually knowing the subject. Yet, their own traders are unable to beat the market and their clients lose money. Guided broadly by some fundamentals, the markets then rally mostly on sentiment. The job of the analyst is to disregard this truth about sentiment and to justify every valuation in the park, howsoever absurd. That is where the expertise of the analyst actually is needed. When the market fell to below 16000 in one day of panic selling on 22 January 2008, everyone on CNBC was shocked at the extent of the cut and advised ‘long term investors’ to enter into the ‘correction’. It was good strategy as people liquidating positions had to sell to somebody and these idiotic comments were as much denial as malice. These comments to buy petered out by the time 10000 was on the Sensex which was the actual level to enter. Why I call 10000 as the entry point instead of 16000 is simple. Sensex TTM P/E in end 2008 was 824. Even if we assumed positive earnings of 10% instead of the actual negative 10% we would have come across 900 forward earnings for FY10. At a forward P/E valuation of 15x, the Sensex should have still traded only at 13500. However, the figures of 15-18x are usually used in bull markets. By the PEG theory, forward P/E should equal EPS growth. This would have implied fair value of the Sensex at 10x or 9000. I wish I was smart enough to realize all this then and had bought bucketloads of stocks then. The point I wish to make is that the livelihood of the financial companies depend heavily on the capital markets. Market over exuberance is extremely profitable as it leads to tremendous growth of the financial services industry. Senseless valuations and forecasts are much more profitable than sober ones.
Ramping up prematurely
On fundamentals, the market should never have touched 21000. It did not deserve the level then and does not deserve it today. It did not deserve 18000 either. The move up to these levels has only benefited a few traders and financial ‘experts’, giving them the license to make idiotic charts that project irrational returns. In the long run the market has survived at neither of these levels.Even when the green shoots were clear in 2009-10, Europe was a concern that had the potential to explode any time. From this time to mid 2011, analysts once again utilized the opportunity to profit from gullible investors by selling them products at 18000 and 19000 Sensex levels by nicely showing them charts of twelve month returns. Of course at these levels neither the debt crises nor commodity based inflation was priced in. They were back to the forecasts of yore projecting 25000-30000 for the Sensex as the ‘India growth story’ is still intact. The India growth story has been a much abused term. It was responsible for the decoupling theory of 2007 that famously predicted that Indian markets would not at all be affected at all by the subprime crisis.
Strategy of fooling long term investors
The analysts will never tell you that markets are not sexy. That would negatively affect their profession. The big investors, funds and brokerages always try their best to profit at the expense of the public. At the end of the day, the public is the one holding stocks at the highest levels. The brokerages quietly sell out in the rallies, the rallies themselves being engineered. As engineered rallies are costly to sustain, the the index retraces its gains after some time. Carefully observe the Sensex yo-yos in the last few years. You will observe a lot of trading ranges. These ranges have usually been broken on the downside in spite of consistent buy calls from brokerages. However, the public is left holding stocks from the highs of these rallies. If the institutional investors actually sold without creating artificial rallies, they would create precipitous declines. Instrumental in the artificial rally is the role of the momentum trader. No wonder that India’s stock market trading volumes are the highest in the world but the cash market volumes are in single digits. These artificial rallies have terribly low delivery volumes. When these rallies peter out, the value or long term investor is exhorted to save the skin of the large institutional investors who wants to sell without creating selling panic. These market manipulations are centuries old and still manage to find fresh losers.
If we assume 1150 as the Sensex EPS twelve months down the line, a valuation of 12x suggests fair value at 13800. Do I suggest buying at 13800? Yes, but only if you are not invested at present. Besides, a crack to 13800 could as well send the index crashing to 12000. My reluctance stems from the fact that Rs 1150 on a base of 13800 yields 8.3%. Risk free interest rates are at 9%+. Thus, unless we officially believe in monkey forces and the greater fool theory, there can be no justification for investing even at that level. I wholeheartedly believe in the greater fool theory as it has been the primary mover of Indian markets in the last five years but it is a theory only for traders, not for investors. The recent rally in the Sensex of 1000 points is in my opinion, nothing more than a suckers rally. Even if the index rallies to higher levels, there are no real fundamentals for an extensive bull run. A move higher would continue the long term bear market and draw more losers at higher levels (this is exactly the opposite of what a technical analyst will claim.) There has to be a change in fundamentals for a bull run. Look at the problems in Europe, US and now China. Every positive development claimed such as improvement in US GDP growth and unemployment numbers has only short term relevance as the underlying debt and related concerns cannot be wished away. China has had a huge real estate bubble and the voices of a soft landing following the bubble burst sound so 2007. I was a big bull from 2004-2008 but have been a net seller since May 2008. Secular bull runs start from compelling valuations, not from fair value or marginally overweight valuations. Bull runs are scripted in graveyards.
http://www.moneycontrol.com Sensex Target of 23950-25000 in 2008 – Citi http://www.dalalstreet.biz/investor/2008/01/sensex-target-of-23950-25000-in-2008/
Reminiscences of a stock operator by Edwin Lefèvre