Vivek Kaul
It is that time of the year when the stock market analysts get busy predicting what levels do they see Sensex/Nifty reaching during the course of the next financial year.
First off the blocks this year are Gautam Chhaochharia and Sanjena Dadawala of UBS Global Research, who have predicted that the NSE Nifty will touch 9,600 points by the end of 2015. As I write this, the Nifty is trading at around 8375 points. Hence, the UBS analysts are basically talking about the Nifty index, rallying by around 15% over the course of the next thirteen and a half months by end 2015.
The prediction of 9,600 points has been arrived at by making certain assumptions, including the expectation of earnings of companies growing by 15% during the course of the next financial year (i.e. the period between April 1, 2015 and March 31, 2016).
Over the next few weeks you will see a spate of analysts of making such predictions. And it won’t be surprising if someone comes up with a Nifty target of 10,000 points or more. For one, saying that Nifty will touch 10,000 points is inherently more sexier than saying Nifty will touch 9,600 points. A big round number always sounds so much better.
Further, Nifty at 10,000 points will be around 19.4% higher than the current level of 8375 points. It has rallied by 32.6% during the course of this year (from January 2014 to November 13, 2014). Hence, a rally of 19.4%, assuming that Nifty will touch 10,000 by end 2015, sounds pretty reasonable.
Nevertheless, the question is how do these analysts know? John Kenneth Galbraith explains this in his book The Economics of Innocent Fraud. As he writes “The fraud begins with a controlling fact, inescapably evident but universally ignored. It is that the future of economic performance of the economy, the passage from good times to recession or depression and back, cannot be foretold. There are more ample predictions but no firm knowledge.”
And why is that ?“There is the variable effect of exports, imports, capital movements and corporate, public and government reaction thereto. Thus the all-too-evident-fact: The combined result of the unknown cannot be known,” writes Galbraith.
Nevertheless, these predictions serve a useful purpose. They tell people what they want to hear, especially during a bull market, when share prices are going up and people are inherently optimistic about things. As Galbraith puts it “The men and women so engaged[i.e. the ones making the predictions] believe and are believed by others to have knowledge of the unknown; research is thought to create such knowledge. Because what is predicted is what others wish to hear and what they wish to profit or have some return from, hope or need covers reality.”
The stock market rally this year has been more about “easy money” from abroad coming into India, rather than any fundamental improvement in economic activity. Since the beginning of the year (and upto November 13,2014) foreign institutional investors have made a net investment of Rs 67,359.4 crore into the Indian stock market.
This has largely been on account of Western central banks maintaining low interest rates. Hence, foreign investors have been able to borrow money at low interest rates and invest it in the Indian stock market. The inflows have been particularly strong since May, when Narendra Modi came to power. Since May 2014, Rs 35,545.7 crore has been the net investment made by FIIs in India.
The basic point is that in an environment where easy money is essentially driving up stock prices, predictions are more about understanding investor psychology than the underlying fundamentals of the market.
An excellent analogy here is that of Henry Blodget, who used to work as a senior analyst with the Wall Street firm CIBC Oppenheimer, in the late 1990s. In October 1998, Blodget brought out a report on Amazon.com. In this report he had predicted that the stock would go past $150 in a year’s time. He had also added in that report that the stock was worth anywhere between $150 and $500. At that point of time, the stock was quoting at $80. The stock raced past Blodget’s one-year target within a few weeks, so huge was the flow of money into the stock market.
His sales team then began to pester him for a new target. By December 1998, the price of the Amazon stock had crossed $200. As Maggie Mahar recounts in Bull!—A History of the Boom and Bust, 1982–2004 “Privately, he[Blodget] was confident that Amazon would hit $400—he just didn’t know if he had the balls to say it. But as his very first boss on Wall Street had told him, “You’re not a portfolio manager—you‘re not trying to sneak quietly into a stock before someone else sees it. You’re an analyst: your job is to go out and take a position.”
And that is what Blodget did. He took the position that Amazon would hit $400 within a year’s time. There must have been hundreds of other analysts on Wall Street who could have said the same thing. It was just that Blodget had the balls to say the right thing at the right time. He told the stock market what it wanted to hear.
Blodget put out his recommendation of Amazon hitting $400 on December 16, 1998. Within minutes, his forecast was traveling around the world. A Bloomberg reporter got a tip and put out the story. Soon, CNBC picked it up. And in no time, the recommendation had hit the chat boards across the various internet sites. And once that happened, the stock simply went through the roof. Amazon, which had closed at a price of $242.75 on December 15, 1998, closed 19 percent higher at $289 on December 16, 1998.
After this, the price of Amazon went on a roll. The stock was split in early January 1999, and the price crossed the $400 level that Blodget had predicted in March 1999, in split adjusted terms. Blodget got the investor psychology right. At some level, Blodget understood that he was in the midst of a stock market driven more by emotion and momentum. Hence, more than the price of the stock, he had to predict investor psychology and where that could take the price.
The Indian stock market is going through a similar era of easy money right now, though of a lower degree in comparison to the dot-com bubble that was on in the United States in the late 1990s. Hence, making predictions is going to about predicting investor psychology than the underlying fundamentals.
Given this, it won’t be surprising to see forecasts predicting that Nifty will cross 10,000 points next year, coming out over the next few years. Of course all these forecasts will indulge in what American writer Steven Pinker calls “compulsive hedging”. As he writes in his new book The Sense of Style “Many writers cushion their prose with wads of fluff that imply that they are not willing to stand behind what they are saying.”
The UBS analysts do just that. After predicting that Nifty will touch 9600 points by end 2015. They go on to write “If our expectations of the earnings growth recovery are not met (with only 10-12% growth in corporate earnings)…the Nifty could decline to the 7,500 levels.”
So much for being in the business of making predictions.
The article originally appeared on www.FirstBiz.com on Nov 15, 2014
(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])