November 25, 2013

Can Vishy Anand make it again ever?



Much as I was disappointed with Vishy Anand not retaining the world championship, I felt better when I  chanced upon an article in Hindustan Times that contained a nice table about the details of the former world champions. A slight rearrangement of that table provides fabulous insights. During the last 128 years (since 1886), only 20 geniuses managed to win the championship. In other words, it is a small tight club with high entry barriers. Champions in the past have reigned for many years before they let the crown fall from their heads. On top of the table is Emmauel Lasker who reigned for 27 years in a row without any interruptions. This was followed by Alexander Alekhine with 17 years of reign, though not unbroken. He had a small 2 year break in between. Then a more familiar name emerges; Anatoly Karpov from Russia, who reigned for 16 years with an 8 year break in between. Another genius Mikhail Botvinnik reigned for 13 years from 1948 to 1963, with 2 intermittent breaks. Next in line were three people who reigned for 8 years each. Our very own Vishy Anand, Wilhelm Steinitz and Garry Kasporov achieved this feat in 3 different centuries!

The record book then shows several champions reigning for continuous periods of 6,3,2, and 1 year(s) but none of them could manage a comeback, including the magical Robert Fischer. As I see it, the ability to come back and clinch the title again is very rare and was noticed only among three people in the yester years. In recent times, Vishy Anand is the solitary champion who won back the mantle after a 5-year hiatus from 2002 to 2007.

The question then is, after this recent loss, will Anand just fade away like the 15 other champions or will he mount another successful campaign to take back the crown. The odds are clearly against him in terms of statistics. But isn’t Anand born to defy odds?


PS: Congratulations to Carlsen on his virgin entry into this exclusive club of champions. 


CHAMPIONS
REIGNED FOR..
REIGN
COUNTRY
Emmanuel Lasker
27
1894-1921
Germany
Alexander Alekhine
17
1927-35, 1937-46
Russia, France
Anatoly Karpov
16
1975-85, 1993-99
Soviet Union (Russia)
Mikhail Botvinnik
13
1948-57, 1958-60, 1961-63
Soviet Union (Russia)
Wilhelm Steinitz
8
1886-94
Austria, Hungary, England, USA
Garry Kasparov
8
1985-93
Soviet Union (Russia)
Viswanathan Anand
8
2000-02, 2007-13
India
Jose Raul Capablanca
6
1921-27
Cuba
Tigran Petrosian
6
1963-69
Soviet Union (Armenia)
Boris Spassky
3
1969-72
Soviet Union (Russia)
Robert J Fischer
3
1972-75
USA
Max Euwe
2
1935-37
Netherlands
Ruslan Ponomariov
2
2002-04
Ukraine
Vassily Smyslov
1
1957-58
Soviet Union (Russia)
Mikhail Tal
1
1960-61
Soviet Union (Latvia)
Alexander Khalifman
1
1999-2000
Russia
Rustam Kasimdzhanov
1
2004-05
Uzbekistan
Veselin Topalov
1
2005-06
Bulgaria
Vladmir Kramnik
1
2006-07
Russia
Magnus Carlsen
0
2013-
Norway

November 11, 2013

SENSEX@2025


This article was published in the November edition of The Global Analyst.


It is a common question to probe as to where would the Sensex be say in 5, 10 or 20 years. Currently Sensex is trading around 20,000 levels and its historic peak was 21,206.77 achieved on January 10, 2008.
To cut a long story short, let me tell you first my findings and launch into explanation later. I expect Sensex to touch 51,000 by 2020 and circa 100,000 by 2025. 


Sensex had a modest beginning in 1978 when it was launched with a base value of 100. Granular level data is available only from 1991 in the Bombay Stock Exchange website. In the 90’s it crossed 1,000 and in the 2000’s it crossed 4,000. In its 35 year history, Sensex averaged an annualized return of 17.3% outclassing all other asset class performance. 


While the base case call for Sensex in 2025 is circa 100,000, the optimistic call could be 155,657 and pessimistic call could be 68,454. The situation such optimistic or pessimistic scenarios could unfold is explained later. The base case call of 100,000 implies an annualized performance of 13.4% between 2012 and 2025 compared to 14.14% achieved during the last 12 years.


The period between 1980 to 2000 can be classified as “lost decades” where average economic growth (measured in real GDP) was below 6% with high inflation. Even under such circumstances, Sensex performance was exemplary especially during the decade of 1981-90 where the annualized growth in Sensex was nearly 22%. The decade of 2001-2010 can be termed “golden” with economic growth averaging 7.5%, inflation benign at 6.4% and Sensex performance was nearly 18%p.a. Viewed in this context, the call of 100,000 for Sensex by 2025 implies an annualized performance of 13.4% where economic growth is expected to average 6.18% with inflation at close to 9%.

Period
CAGR of SENSEX returns
Avg Real GDP Growth (in %)
Average Inflation (consumer avg prices, %)
1981-1990
21.60%
5.59
8.88
1991-2000
14.25%
5.58
9.05
2001-2010
17.84%
7.39
6.37
2012-2025*
13.41%
6.18
8.98
*Average computed only till the year 2018 as IMF forecasts are available only till that year

The projection methodology
1.     Historical values (closing price, P/E, div yield, P/BV, earnings, book value and dividends) from 1991 to 2012 were taken from BSE website.
2.     Base case scenarios were considered based on historical averages.
3.     Ratios (P/E, P/B & dividend Yield) were projected based on their respective historical averages.
For example, P/E ratio in ensuing 4 years was considered to be average of past 4 years (2012-2009) P/E and so on.
4.     Earnings, Book Value and Dividend growth for the first 6 years were assumed to be a constant growth (average of past 6 years). Incremental projections included the subsequent historical year.
5.     In order to project future values an upside of 25% (optimistic) and downside of 25% (pessimistic) was considered for the parameters (ratios, earnings growth, div.& book value growth) under consideration.
6.     Based on the various scenarios (optimistic, base case & pessimistic) the future values were computed.

The Drivers



 There are two primary drivers and two ancillary drivers for Sensex. The main primary driver is the economic/business cycle. According to Pami Dua and Anirvan Banerji[1], the Indian business goes through peaks and troughs. Normally the duration from peak to trough is relatively much smaller compared to trough to peak. In the Indian context, the duration of peak to trough lasts for approximately one year while the duration of trough to peak lasts for 4.3 years yielding total cycle duration of 5.25 years. The path of peak to trough is marked by recession leading to curtailment of investments and therefore negatively impacts company earnings and stock price performance. The path of trough to peak is accompanied by growth leading to capital investment and will normally witness earnings expansion. Hence economic/business cycle tend to impact earnings either positively or negatively depending on the nature of the cycle.
The second most important driver for Sensex would be the earnings, through which we derive in what is most famously followed metric called P/E ratio. The P/E ratio can move higher either because of increase in market price (numerator) or because of decrease in earnings (denominator) and vice-versa. As we can decipher from the chart, the P/E for Sensex ranged from a high of 45 in 1994 to a low of 13 in 1998 with a mean of 21. Episodes of bull market will magnify the P/E and take it to over valuation levels while bear markets produces subdued P/E. The key driver to the P/E ratio is the earnings (the denominator) which has shown remarkable progress during the period since 1991. Sensex earnings have since grown from a modest 85 in 1991 to 1,133 in 2012 implying an annualized growth of 13%.



Another key stock market metric is the price to book ratio (P/B). The book value (denominator) is defined as the total net worth which includes both equity as well as accumulated reserves (the portion that is retained in the business and not distributed as dividends). Book value growth is concomitant on earnings growth. Historically the P/B ratio hit a high of 6.35 (1992) and a low of 2.3 (2002) with a mean of 3.72. The book value rose from a modest 533 in 1991 to 6,307 in 2012 implying an annualized growth of 12%.
And finally the dividend yield which is simply dividends divided by the market capitalization. Higher dividends or lower market capitalization can improve the yield and vice-versa. Business that are experience growth will be loath to increase dividends as they feel that money can be better served in the business than in the hands of investors. Mature companies tend to favor higher dividends as they find fewer opportunities to redeploy earnings. The dividend yield fluctuated from a low of 0.68 (1994) to a high of 2.14 (2002, 2003).

Factors that can influence the Scenarios
In my assessment, there are 4 key factors that will influence the performance of Sensex in the next 12 years i.e., global growth, foreign investment, inflation and credit rating. In a globalized and networked world, the performance of the global economy (especially the developed world) will have a great significance on the performance of emerging markets like India. The jury is still not out on whether global growth has stabilized. Thanks to the global financial crisis, leading multilateral agencies (like IMF and World Bank) have been continuously revising the global growth outlook on the downside. There is a predominant view that global growth has settled to a “new normal” low and high growth rates are a thing of past. India’s stock market performance is significantly dependent on whether global growth will stabilize and pick up (the optimistic case) or will falter and fail (pessimistic case).
The second factor is the foreign investment both on infrastructure investment (FDI) and portfolio investments (FII). India’s track record on this has been dismal so far especially when benchmarked with China. However, a change of guard in the government and unleashing of policies that are foreign investment friendly can produce the optimistic case. It is also possible that politics will dominate economics here and India may continue to pursue “unfriendly” foreign investment policies which will produce the pessimistic scenario.
The third factor is inflation, which is an enemy for stock market performance. The monetary policies of RBI has so far been a failure in containing inflation since the problem is understood to have emanated more from a  supply bottleneck rather than demand induced. However, persisting high inflation will be viewed very negatively by investors (read foreign) and may unleash the pessimistic scenario. However, if RBI and the government succeed in taming the inflation, then we may be in for a pleasant surprise in terms of stock market performance.
And finally, India’s sovereign credit rating is now in the last leg of investment grade. A notch below this will classify India into “junk” status and there are many reasons (high current account deficit, fiscal deficit, inflation, etc.) as to why this can happen. And if that happens, the pessimistic scenario will unfold. However, if government policies can produce credible improvement in the economic scorecard, we can even see India moving up the investment grade rating which will be music.


The final word
Equity as an asset class has always performed far better than other alternatives but with only one caveat i.e., volatility. What has been discussed and shown in this article is only the return side of the story. However, the risk that one has to take to achieve these returns is also equally significant. A simple tool to measure risk is the standard deviation but there are other equally important measures of risk as well. Equity is one asset class which will dissuade investors from holding on due to its inherent volatility. Investors that can stomach this volatility and hold on to the investment can certainly reap the benefit. However, studies have repeatedly shown that investors show scant tolerance to holding up their equity investments and make erroneous entry and exit decisions that are harmful to their performance. In other words, they time their investments mostly wrongly leading to underperformance. Technology has enabled investors to buy the market (read Sensex) through cost effective solutions in the form of exchange traded funds (ETF’s). All one has to do is to invest in the ETF and ride through the time without getting distracted. Difficult isn’t?


[1] Business Cycles in India (2006)

 The author thanks Rajesh Dheenathayalan for his assistance