Can the Sensex easily add few thousand points more? - The 5 Minute WrapUp by Equitymaster
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Can the Sensex easily add few thousand points more?

Dec 4, 2014

In this issue:
» The size of some of the big disinvestments lined up
» The tower of debt getting taller and taller
» Commodity producers in a dilemma
» ....and more!

The biggest news in the stock markets today is of course Rakesh Jhunjhunwala's bold, or rather very bold prediction. The Big Bull is of the view that he would be disappointed if the Nifty doesn't touch 1,25,000 by 2030! For those whose frequency is attuned to the Sensex, this means a Sensex level of 4,20,000, nearly 15 times higher from its current levels.

Needless to say this is too far into the future and with too many ifs and buts along the way. We however are going to focus on what lies in the immediate future. The next 2-3 years if you will. And as far as this time period is concerned, we seem to be on solid grounds. If everything goes as per plan, we see this rally having some more steam left. Yes, that's right. No doubt the indices have touched record highs. But a few thousand points on the Sensex seem very much on the cards.

And why do we say that? Well, to know the reason, we will have to go back in history a bit and revisit the tech bubble days of the year 1999-00 in the US.

With the benefit of hindsight, we now know that the conditions were ripe for a disaster and that's how it exactly ended. But with the crowd of investors so much drunk with euphoria back then, it was next to impossible to find a sober head popping out and warning us of the impending danger.

Fortunately, one man did just that and he answers to the name of Warren Buffett. Please note that Buffett barely ever makes market predictions. But whenever he has done so, he has been spookingly accurate.

So, what was he predicting back then? His argument was simple. People were simply looking into the rear view mirror when their focus should be on the windshields. In other words, assuming future returns to exactly mirror the past would be a cardinal mistake. And born out of this was his view that stocks are unlikely to return anywhere close to 15% that they returned per year over the previous two decade or so.

How exactly did he arrive at this conclusion? He was of the view that the ultimate driver of the markets was of course the growth in earnings which in turn was based on GDP growth rates. However, there's another factor that connects the two. And it is nothing but corporate profits as a percentage of GDP. It is this ratio which determines how much of a country's GDP falls into the lap of shareholders and therefore, the higher it is the better.

However, do note that there are many others who want to claim their share of the GDP pie. Stakeholders like the workers, providers of debt capital and of course the Government who needs to collect taxes. Consequently, the corporate profit to GDP has averaged a certain number over the years and as per Buffett it was running above the normal bands at the time of tech bubble.

Another driving factor is of course the interest rates. And even here, the US economy was on shaky grounds as rates were already the lowest they had been in many years.

So with no further help from corporate profits to GDP ratio and also interest rates, it was obvious to Buffett that the next few years could see stocks growing at a much lower rate than before. And we all know how it ended up, don't we?

Now, if we need to make an educated guess about Indian stock markets, it is obvious these are the two parameters we should start with.

Fortunately for us, there has been a recent article in leading news daily about this. And the view is nothing but sanguine. Turns out corporate profits in India as a percentage of GDP are still 30% below the last year 10 average. Thus, if they were to normalise and India manages to grow its GDP in the range of about 7%, good gains are certainly there for the taking.

And you know what, we aren't even talking about interest rates yet, which if they are lowered, can easily provide the additional kicker. Of course, nothing is certain in investing. But we see a stronger chance of the indices going even higher from here. And a correction if any should be looked upon as an opportunity to load up on some good quality names at attractive prices.

What do you think? Do you think there's still a good deal of room for the indices to go higher? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
Look who's making use of the buoyant market sentiments? None other than the Government itself. Its new disinvestment program goes underway shortly. Starting with PSU steel behemoth SAIL, the centre will kick off its own divestment program tomorrow when it will put 5% of its stake in the company up for sale. If the calculations are anything to go by, the Government should be able to mop up around Rs 18 bn from the sale. This is of course the first of many more disinvestments to come and if the markets behave themselves, the numbers can easily go few notches higher. However, from a long term perspective, we would very much want the Government to maintain fiscal discipline rather than indulge in selling its assets to meet its yearly expenditure. At this rate, it will have sold off the extra stake in most of its trophy assets in no more than few years.

Government's disinvestment calculations

Just yesterday, we spoke to you about a few stunning facts relating to the US government's propensity to take on debt. To recount, while it took the US government 205 years to accumulate its first trillion in debt in 1981, it took less than 403 days to accumulate its most recent trillion! In the process, taking federal debt to a staggering 103% of the country's GDP. Further, this pace is likely to accelerate further as we move along.

Let's step away for a moment from the world of economics and into the world of construction. Imagine there is a tower that has become shaky because of it being built too high. In a nervous bid to stop the building from collapsing, concrete is being added to its foundations. However, builders are continuing to add additional floors on top! What an absurd sight that would have been right?

Nonetheless, when we get back to the world of developed country economics, this is what we see going on currently with their central bank's policies. And the above is the analogy that ex-senior partner at Boston Consulting Group, Daniel Stetler, drew in an interview recently. Further going on to explain that it is the goal of the central banks of the developed world to avoid the tower of debt from crashing. And in a bid to do that, they are doing everything to keep money cheap. Problem is, this is only bringing up financial assets and inflating asset values, but is not really reviving the real economy. And in the process, the tower of debt is becoming taller and taller. A great analogy we must say, but one that also brings with it some grave implications.

And while we back here in India anxiously await our own capital expenditure (capex) cycle to see a pickup, an impediment to this might just end up coming from the most unexpected of sources - the fall in commodity prices. This fall may be very good news for the macro economic situation in India as well as for many in corporate India. But the flip side to this is that it will mean significantly lower realizations for the producers of these commodities.

A likely consequence of this is that they will start looking at postponing their capital expenditure plans until such time that they see the prices of their respective commodities moving to a more comfortable zone again. And once one considers that the producers of commodities usually tend to have asset heavy business models, it becomes easy to understand just how big a contributor to the capex cycle may very well take a prolonged back seat. We hope this shortfall is more than made up by commodity users who will surely see their costs going down and profits going up.

In the meanwhile, the Indian stock markets remained close to the dotted line for the most part of today. At the time of writing, the BSE-Sensex was trading up by around 70 points. By far the biggest gainer amongst sectoral indices was the BSE FMCG index, which was trading up by about 3%.

 Today's investing mantra
"The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Rahul Shah and Taha Merchant.

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2 Responses to "Can the Sensex easily add few thousand points more?"


Dec 5, 2014

Your comments in 5 minutes wrap up is excellent and very incisive particularly about an industry or a particular stock. But I find some of your own research teams themselves don't follow the advice. eg. Recently you mentioned in 5 minutes wrap up about poor performance of textile stocks. but Researchpro had kept a textile stock and only it was replaced by another stock mainly dealing with fertilisers and hence dependent on Subsidy and vagaries of Govt policy. It goes against basic concept of Warren Buffet viz.pricing power.



Dec 4, 2014


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