The interesting case of Nifty 50 and King Sisyphus

Last week, the Nifty 50 crossed 18,000; again! From the first time it scaled this peak in October 2021, this is the fifth attempt to get to the other side following meaningful corrections each time it crossed 18,000.

Thus so far Nifty 50’s attempts at crossing 18,000 have turned out to be Sisyphean — like the efforts of King Sisyphus of Greek mythology. Condemned by the gods for eternity to repeatedly roll a boulder up a hill, only to have it roll down as he almost completed the task, Sisyphus was made to pay for his violations.

Nifty 50 too, through a time-wise correction over the last two years, has to an extent paid for its violations. Irrational investor exuberance and unrealistic rosy sell-side forecasts have, to an extent, got purged in this time frame.

The key question now? Is the Sisyphean phase of the markets done with? Can equity investors look forward to better times?

If you are a long-term fundamental investor, here are two reasons why the phase may not be over yet.

Valuation is not yet cheap

Yes, valued at 19.5 times one year forward earnings, Nifty 50 is trading in line with its five-year average valuation. Ideally that’s not a bad starting point to consider investing. However, if you scratch the surface and dig deeper, buying at average valuation in the current context might not be that good. Interest rates are higher than the five-year average and earnings growth too is slowing down. So, two important fulcrums on which the levers of fundamental investing rest are not quite in favour. In this context, the valuation, while optically in line with trend, is not cheap. Further, clubbing this with the fact that global economic outlook is clouded, unless valuations are at a discount to long-term average, the case for buying now is not strong. 

Besides, average valuations don’t appear that attractive when you hear about bank failures and risk of recession. Sure, these events are happening far away, but have we ever been immune to the slowdown and recessions in faraway advanced economies? While this is not to predict what exactly will happen this time, the last two times recession hit the US (2008 and 2020), Nifty 50 bottomed at around 35 per cent per cent below its 5-year average valuation. 

Missed earnings forecasts

“The only function of economic forecasting is to make astrology look respectable” – economist John Kenneth Galbraith

These profound words from one of the most famous economists have been well validated in recent years. Most economists have been caught on the wrong foot, be it forecasting inflation or interest rates or economic growth over the last 2 years. What then can come of earnings forecasts which are derivatives of economic forecasts?

A simple analysis of data (Bloomberg) over the last 15 years indicates that in 11 of those years, the one-year forward earnings for Nifty 50 was over-estimated. If you were to extend that, it implies a near 75 per cent probability that the next one-year sell-side consensus forward estimates are overstated. The extent of overestimation has been quite stark with average overestimation across these periods around 20 per cent. Of course, this average is skewed by two factors – high bank NPAs/losses in the past decade as well as recessions (2008; 2020). Of these, while one can take comfort for now that the former is less likely to repeat, one cannot say the same for the latter.

Investor playbook

Amidst these uncertainties what should investors do? If you are a fundamental value investor, there is absolutely no need for you to jump into the 18,000 band wagon. Unlike Sisyphus who picked a boulder, investors must instead focus on picking discarded pebbles. For example, an investor who ignored IT sector last year due to its high valuation and instead picked up ITC has fared well by now.

At the index level, the right time to get aggressive would be when it is trading below average valuation and earnings outlook is more realistic, factoring the risks. Right now, we are not there yet. Thus, there is a good chance that the boulder will have one more trip down the hill sometime in future.

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