Why long-term Sensex targets resemble a house of cards

“The only function of economic forecasting is to make astrology look respectable” – those are the words of one of the famous economists of the 20th century – John Kenneth Galbraith. Sometimes though, stock market pundits try to find their place in the quote, replacing economists, with overly aggressive Sensex and Nifty targets for the long term. Crystal-ball gazing is fun and might also give a perspective, but when it comes to making predictions that can influence people’s decision with their hard-earned money, baking in some caution will not hurt.

Low credibility risk

Long-term targets are safe to make for market observers because, by the time we reach that point in time in future for which the prediction was made, the world is caught up with things relevant to that point in time with scant memory or regard for predictions made 10 years back. Hence, one can make bold predictions on where Sensex will be in 2030 or 2050 without much risk of losing credibility. Mention the risks and make footnotes, one also has a useful excuse, if a question is raised in future.

For example, in 2010, there was a report predicting that we could be a $4.5-trillion economy by 2020. Well, we barely managed to reach $3 trillion by 2020. That’s like aiming for 100 and scoring 65! This highlights how long-term forecasting can be way off the mark. Today, no one is really bothered about what was predicted in 2010 on where economy would be in 2020. While one could argue many unexpected things happened, it is entirely plausible that in a long time frame unexpected things will happen. That no margin of safety is sometimes factored in for unexpected events while forecasting for the long term is probably a reason why Galbraith considered astrologers better off.

Human beings, in general, tend to have a cognitive social bias known as the ‘hot hand fallacy’. This bias is a result of extrapolating past success to the future. For example, after more than a doubling of Sensex from its March 2020 lows, something which no one predicted, market bulls may tend to extrapolate this into the long term, driven by confidence in market performance over the last year. When such optimism from recent events is extended to a 10-year period, there is a very high probability of missing the target by a wide margin.

If one observes closely, headline-grabbing long-term targets are shelled out only during times of optimism and euphoria in markets. Why is this not done during a bear market? Ideally, for the long term, one short bear market should not matter, isn’t it? This is reflective of forecasters being influenced by recent trends and events.

Investors, however, need to note that the fundamental value of an asset is the same, irrespective of the perception of market participants and recent returns. The more the asset gets valued now factoring in optimistic scenarios, the lower will be its future returns and vice versa. Hence, the time to get cautious on long-term returns is after a period of exceptional returns like in the last one year when a lot of optimism about the future is already priced in.

Holistic analysis absent

‘You torture a data long enough it will confess’ — in general, humans have a tendency to be selective in data analysis and ignore contrary data points in a way that is in sync with their line of thinking. There is a phenomenon called motivated reasoning where we come to conclusions that we are predisposed to believe in. Hence, a market bull may be influenced by motivated reasoning to give aggressive long-term targets like 2,00,000 for the Sensex by 2030, and another to give a target of 1,00,000 by 2025. Bears too may be under the influence of motivated reasoning, but they usually are more focussed on the near term.

A holistic analysis of the data will pose strong questions to test the assumptions based on which bullish targets are given out. For example, some of the optimistic Sensex targets are based on expectations that India can grow its nominal GDP by 12-13 per cent over the next decade from the current around $3 trillion. The growth rate of China since 2006, when its GDP was at $3 trillion, is assumed to play out in India. Whether this plays or not itself is in doubt as India and China economies have a lot of structural differences.

Besides, if we expect to grow like China, we must also analyse why since 2006 to 2020, when the Chinese economy grew at 12 per cent, the major Chinese index — SSE Composite — gave CAGR returns of only 7.5 per cent. There is an implicit assumption that market returns in India will be above the nominal GDP CAGR which is required to achieve long-term targets. While a few data points may be supportive of this assumption, a lot of data points will also be supportive of the alternate assumption that market CAGR could be lower.

Similarly, another thing to question is current long-term targets are based on aggressive CAGRs from current index level when the index is trading at around 50 per cent premium to 10-year average trailing PE and 30 per cent premium to five-year average. Reaching Sensex level of 200,000 by 2030, for instance, implies that these valuations will sustain, based on the GDP/corporate earnings growth assumed. This, then, would also require that in the year 2030, interest rates in India and the developed countries are at historically low levels like now and quantitative easing (QE) by global central banks is in full flow, as these are factors that have driven the current premium valuation vs historical levels. Alternatively, in the absence of low interest rates and QE, what factor would justify the current premium PE valuation to be the prevailing PE valuation in 2030? Thus, the assumptions made must be taken with a pinch of salt.

Whether it is economy or Sensex targets for the ultra long-term, don’t fall for it now. The future in a dynamically changing world is more uncertain than ever. Some predictions may turn true out of luck, many will not.

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