Sensex at 29,24,100!

While I don't intend to take potshots at individuals in this blog but sometimes the interest of the public at-large takes precedence over name-calling. Recently I read the following interview of Mr. Ajit Dayal in Hindu Business Line. In his interview, Mr. Dayal made a wager that over the next 30 years the BSE Sensex would probably grow 171 times (hence the number 29,24,100 = 17,100 x 171). Per my knowledge he is certainly not in the league of Indian super-investors like Rakesh Jhunjhunwala or Sunil Singhania but he does seem to have built a reputation for himself. He is the founder of Equitymaster & Quantam Asset Management which claims to advice Rs. 2500 crore of FII money. He was the country head/director of India operations for several well-known foreign investment firms. As per Equitymaster's website he has also been voted as best analyst for India by AsiaMoney in 1993 & 1994.


The BSE Sensex has indeed grown 171 times over the last 30 years. Without even considering the contribution from dividends this equates to a return of 18.7% which is truely amazing. Mr. Dayal expects similar returns over the next 30 years. I truely have no idea of what the future returns would be over the next 30 years but from my understanding no equity market in world has shown this kind of returns over a strech of 60 years (neither Japan, USA or West Germany during their spectacular growth phase). I think the main reason for the exceptionally high returns of the past 30 years in India are: valuation multiple expansion, inflation and dramatic devaluation in rupee from 1/8 per US$ to 1/48 per US$ because as per purchasing price parity which prevails over the long term more units of money would be needed to buy the same physical entity i.e. the companies in the Sensex. The prospects of all three of these factors expanding at the same rate over the next 30 years are not very high and the only other remaining factor (i.e. real earnings growth) in the return equation cannot grow fast enough to yield a 20% (18.7 % capital appreciation x 1.1% dividend yield) total return.

In such rosy forecasts lies the follies of excessive optimism by investors which is invariably fueled by self-serving investment advisers and market pundits. By assuming abnormally high returns on their savings, investors run the risk of running out of money just when they would need it the most (i.e. at old age when they cannot earn money through other means). Market returns everywhere have exhibited mean-reversion over a long period of time (e.g. after growing fast for 1-2 decades, US market have chocked for long periods of time: 1899-1920, 1964-1981; same is the case with Japan where the Nikkei at around 10,000 is way below its 1989 peak of 38957). The process also works in reverse i.e. investors should not be overly pessimistic when the markets are under stress (e.g. US in 1981, India in 2002 & perhaps in Oct. 2008 and possibly Japan today!!).

Still not convinced? Check out the following excerpts from a recent letter to Berkshire Hathaway's shareholders by the Oracle of Omaha. One might argue that Mr. Buffett is speaking in the context of US investors but please note that he is no stranger to emerging markets after having made a fortune by investing in South Korean companies & Petro China. In one of the future posts, I will also address the myth of higher economic growth = higher stock market returns when investing in emerging markets like India.