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What has driven Sensex in past bull markets?
Jun 20, 2014

When it comes to equity markets, a glance in the past can give a good idea about how things could possibly shape up in the future.

Today, we look at some of the sharp run ups in the Sensex i.e. bull runs in the past and try to gauge what has been the key driver for the same.

As you would be aware, the price of any stock or for that matter an index which is made up of various stocks, is nothing but the EPS multiplied by the P/E earnings ratio of the stock or the index.

For example, the BSE-Sensex at present has an EPS of about Rs 1,352. It currently trades at a P/E of 18.6 times. Multiply the two and you get a figure that is close to the current Sensex level.

And it therefore follows that any future price or index levels will depend on the growth or fall in the EPS and the expansion or the contraction in the P/E multiple.

We tried to go back in time and see which of these two factors i.e. P/E expansion or an increase in EPS has led to the rise in the index. And the chart below is the final outcome of our study. It indicates the weightage both these factors have had in the historical market run ups.

It may be noted that we have only selected the periods post Jan 1991, and have chosen those bull runs that touched new highs as compared to the preceding one. The start date of those bull runs was the low price touched prior to the run up.

Prima facie, what is interesting to note is the duration of the market run ups. All those upswings which were led by P/E expansions did not last for too long. The cases in point being the market run ups from January 1991 to April 1992, April 1993 to September 1994, October 1998 to February 2000 and March 2009 to November 2010. What is also common is that from the highs, the markets corrected when valuations were quite high; in each of these cases the P/E stood in excess of 24 times its trailing twelve month earnings.

Currently, the Sensex trading at about 18.6 times, thereby indicating that there is no real sign of worry if the past corrections are any indication.

On the other hand, the run ups from April 2003 to January 2008 as well as the current run up i.e. from December 2011 till now have largely been driven by an increase in earnings. The latter cannot be considered as the market peak since the run up is still ongoing at the moment.

But what we can say is that with the market trading close to its long term historical valuations, the focus will be on earnings growth going forward. But if the P/E continues to rise the way it has been in the past three months - i.e. without the adequate support of the earnings growth - it could lead to an overheating situation given the limited scope of P/E expansion.

Thus, it could make sense to not pay too high multiples to stocks and also stay away from the ones which are fundamentally weak but have gone up only in the expectations of better days going forward.

What will drive the Sensex going forward: P/E expansion or increase in earnings? Let us know in the Equitymaster Club or share your comments below.

P.S.: Imagine a city with live music in every lane, sign up for the latest on NSPA street performances across Mumbai city.

Data Source: Equitymaster Research, ACE Equity

This Chart Of The Day was published in The 5 Minute WrapUp - Is the ongoing bull market here to stay?

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