What should you make of the Sensex 40,000 target? - The 5 Minute WrapUp by Equitymaster
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What should you make of the Sensex 40,000 target?

Nov 19, 2014

In this issue:
» Jeremy Grantham on energy prices...
» Investments via P-notes at 7-year high!
» Government's boost for capital goods sector
» Indian markets slip into the red during the post noon trading session
» ...and more!

The BSE-Sensex breached the four figure mark (1,000) for the first time on 25th July 1990. It took just a year, for the index to double. And another two years to double once again. However, after that it was a long 13 year wait for investors to see their money multiply. And needless to say, we are already in the seventh year after the Sensex doubled the last time in 2007.

How often does Sensex double?
Year Sensex CAGR Years taken to double
1990 1,000    
1991 2,000 100% 1
1992 4,000 100% 1
2005 8,000 5% 13
2007 16,000 41% 2
Source: BSE

Are you still wondering what the point we are trying to drive home is? Well it is simply the fact that Sensex predictions come with their fair share of salt. There is no doubt that driven by higher earnings and possibly higher multiples, the Sensex will move to 40,000, 50,000 and even 100,000 at some point of time. However, as we just saw, how soon these figures will be breached is anybody's guess. Therefore investing based on Sensex targets can be as risky as driving blindfolded!

The author of the 'Greed and Fear' report, Chris Wood, Managing Director and Chief Strategist of CLSA, is deft at managing both the emotions. His latest prediction of the benchmark Sensex climbing to 40,000 levels should therefore also be viewed in that context.

With more than 30% gains since the start of the year. The Sensex enjoys the tag of the best performing index globally in 2014. Does that mean another 40% gain to reach the 40000 mark is not possible? Well, that is certainly not the case. But investors need to reckon how soon and whether at all the earnings growth of Indian companies will justify such gains.

Chris Wood himself has clarified that his prediction is primarily based on an upturn in investment cycle in India. And the lack of evidence of such evidence within a period of two years, could make the Indian markets seem overvalued. Thus the rate at which the Sensex accelerates will depend on more than one fundamental factor. And any uncertainty about macro economic factors (like inflation or fiscal deficit) and corporate growth (reforms to stimulate investments) could delay the Sensex prediction by several years.

So should you as an investor base your decision on such Sensex predictions? Well, the fact that anyone having invested in Indian equities has multiplied his money 27 times, at a CAGR of 15%, over the past 24 years is reason enough to be invested in the asset class. However, it would be wiser to look for the 15% CAGR in individual stocks rather than the Sensex.

Companies that are well managed, sport solid business models and are available at very attractive valuations can be a much better bet to fetch the 15% annual return from stocks on a sustainable basis. This will not just ensure that you beat the Sensex return over a period of time, but also keep your portfolio insured against wayward predictions.

Do you invest based on Sensex targets or your expectations from individual stocks? Let us know your comments or share your views in the Equitymaster Club.

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Now, investing legends like Buffett believe that value investing is as much a science as an art. So to what extent is the process linked to pure sciences? We recently got the answer from yet another renowned practitioner of value investing - Jeremy Grantham. In his latest letter to investors, Grantham has pointed out two critical flaws in investor expectations.

The first - Most forecasting models incorrectly assume endless growth. Our potential for economic growth is limited by the world's finite resources.

The second - The laws of physics will not be defied by economics.

Grantham essentially wants to drive home the point that predictions about cheaper energy prices stimulating growth are short sighted! Looking at oil from a broad perspective and unravelling the commodity's role in economic development in the last 150 years, Grantham has made some startling predictions. He has argued that serial mispricing and misallocation of oil has led us to a place where oil's cost has, and will, continue to hamper potential economic growth.

Taking this point further, companies hoping to fetch higher profits from fall in commodity prices cannot be very long term investment bets. Unless they have adequate pricing power to tide over margin pressures even when commodity prices make a U-turn.

 Chart of the day
It was about two years ago when Mr. Ajit Dayal wrote about how the preference for participatory notes or P-notes was dwindling - especially amongst the total foreign investments flowing into India. And he had also mentioned that that is how it should be considering the short term approaches taken by investors who use such instruments to participate in the Indian growth story. Not to mention their anonymity, which was another matter altogether.

In fact, there were a lot of discussions about the high possibilities of round tripping - a form of money laundering - occurring back then. However, with market watchdog SEBI making the regulations more stringent, investments through this route have come down.

Over time, however things have changed substantially. As reported by the Mint, at its peak in October 2007, the value of investments via P-notes stood at Rs 4.49 trillion. This gradually came down to Rs 3.22 trillion in February 2008 and further fell to Rs 609 bn in February 2009. As of date however, the value of investments through P-notes stands at a much higher figure of Rs 2.6 trillion, which as per the daily is a figure at its 7-year high. As a percentage of the total assets under custody of foreign portfolio investors (FPI), this stood at a figure of 12.2%. However, when gauged in absolute terms, we can easily deduce that investments through this route have been on the rise.

P-notes making a comeback?
EDD - Equity, debt and derivatives; AUC - Assets under custody;
*including offshore derivative instruments

As can be seen from the chart of the day, the outstanding investments in equity markets through the P-notes route stood at Rs 1.6 trillion. But as a percentage of the total assets under custody, equity investments remained close to its past 10-month average of 7.5%. Nevertheless, the value of such investments has risen substantially as the figure stood closer to Rs 1.02 trillion as of January this year.

We cannot say whether it's the enticing Indian growth story or cheap liquidity that is making investors put money into Indian markets in recent times. However, if history is anything to go by, cropping up of any major issue will lead to such capital fleeing from India in no time.

Last year, one of the key concerns surrounding the Indian economy and markets was that of the burgeoning current account deficit figures; and the possible implications of the same - including downgrades by rating agencies. Some of the key reasons for the situation to arise in the first place included India's high oil and gold import bills, coupled with capital fleeing from the country. What was also a less highlighted concern was the high import bills of capital goods. This in fact also resulted in hampering prospects of the domestic manufacturing industry.

However, from what it seems, things could possibly take a turn for the better as steps are being taken to address this issue. As reported by the Mint, the government has an ambitious plan to locally manufacture as many as 181 products which are valued at over US$ 18 bn or Rs 1.1 trillion. For reviving the fortunes of the Indian capital goods sector, the government is also believed to be considering the option of declaring the capital goods sector as a priority one (thereby allowing access to lower interest rates) as well as levying no excise duty on locally made products. In addition, abolishing tax free imports and inclusion of subsidies seem to be on the cards as well.

While there has been no official statement from the government yet, we believe such steps are only likely to give a boost to the Prime Minister's 'Make in India' campaign. Boosting manufacturing is a structural change that is much required. With increased manufacturing activity being one of the seven signals of Golden Decade Megatrend identified by us, we would like to add here that The India Letter team is actively scouting for companies that are best suited to ride this trend over the long term.

After hovering around the dotted line for most part of the day, the Indian stock markets slipped into the red during the post noon trading session. The BSE-Sensex was trading lower by about 157 points or 0.5% at the time of writing. Asian stock markets ended the day on a weak note today; European stocks were witnessing selling pressure.

 Today's investing mantra
"Investors should be skeptical of history-based models. Constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the symbols". - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee.

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5 Responses to "What should you make of the Sensex 40,000 target?"


Nov 21, 2014

It doesn't matter whether sensex is 40,000, 50000 or more. This market is very difficult to understand. It's simply based on individuals luck. Why I am saying so- take the example of RIL. It is one of the best script as far as profitability is concerned, weightage in Sensex is also highest.Many experts stongly recomended it continuously over the past so many years. But the result is - when Sensex was 15000 its stock value was more than what is today when the sensex is over 28000.I have given one example only. There are many many pioneer stocks like RIL, which was recommended by so called experts, are now trading below its purchase price when the sensex was 15000 or below. So my suggestion is that don't go by others recommendation. Apply your own wisdom, study well before investing finally. ONLY SURPLUS MONEY AFTER MEETING ALL YOUR NECESSARY EXPENSES SHOULD BE INVESTED IN STOCK MARKET. Don't be too much greedy. Set small target and Book profit. All the best wishes.

Like (2)

sushant mittra

Nov 20, 2014

I invest on individual stock analysis and also consider expert advises in different channels and sites.
Most cases sensex moves (even spin madly)on the basis of a knee jerk reaction without considering the inherent strength of an enterprise or a situation.

Like (2)

Partha.P Chakraverty

Nov 19, 2014

I am new subscriber to your magazine cum mail based net service, I am amazed to see your business model, well lets talk about the topic that whether individual stock selection is far more judicious than sen-sex !? yes its obvious I have not made money on trading equity but I can brag that no individual or organisation analysis is sufficient still you urself know little bit of not market but overall scenario of world and India. I will just give you recent example of my impulsive investment on two stocks (1) State bank of India & (2) Larsen and Tubro purchased in jan/Feb-2014 and later on oct both share in average gave 100% return so its depends on picking up stock in time and selling in time nothing else and thse scenario always repeats so making wealth is not based of wide analysis but specific analysis picking at bottom and selling on self made target price and patience ofcourse is essential. Thanks

Like (1)

pravin d

Nov 19, 2014

It is always logical to invest based on return potential of individual stocks rather than sensex.

Like (1)

Ganapathy Sastri

Nov 19, 2014

Markets need NOT necessarily be a barometer of the economy. Many macros show that India is still not out of woods. Trade deficit continues to be MASSIVE despite reduction in prices of black gold and yellow gold. Govt deficit continues to be MASSIVE despite reductions in subsidy. Inflation continues in double digits notwithstanding claims from govt statistics. No nation remains for long the best performer. At some point that title will belong to some one else.

Like (1)
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