Why the Nifty is falling and the futility of forecasts

People in the market aren’t happy. This wasn’t how it was supposed to go. Not after a landmark electoral mandate and all the promises it held.

The professionals were unanimous. India was poised for takeoff and so were India’s stock markets…

Dec 2014: Nifty to hit 9,500 by end-2015 on capital inflows: Goldman Sachs (link)

Nov 2014: UBS sees Nifty at 9,600 by 2015-end (link)

Sep 2014: See Nifty at 10,700 by Dec 2015: Bank NIfty to lead: JM Financial (link)

But looks like noone told the Nifty. Departing from script, after steadily rising to the cusp of 9,000 at the beginning of March 2015, it has subsided over 11% since, flirting with diving past even 8,000. The question on a lot of minds is “Why the Nifty is falling?”

The Calm Investor | Nifty in 2015

Not everyone was as exuberant with these optimistic predictions.

Nifty@10,000: Coming soon at a stock market near you (link)

This is an interesting article that refers to a book called ‘The Economics of Innocent Fraud‘ by John Kenneth Galbraith about how the business of market forecasts is in Sheldon Cooper’s words, hokum.

“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.”

“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

But the one purpose they apparently serve is to tell people what they want to hear, especially during a bull market.

I commented on “election fever” and did a historical analysis of Nifty returns given Price-Earnings and the outcome suggested zero to negative returns in 2015. (Predicting stock market returns)

Another way of making sense of what’s been happening is to look at earnings growth versus price (Nifty) levels over the last 15 years. Chart below shows a normalized view of cumulative earnings of Nifty companies and the corresponding price level from Jan 1999 to Jun 2015. In Jan 1999, the Nifty was trading at a modest Price-Earnings of 11.6x.

Basing Jan 1999 Nifty earnings and price at 100 shows us how the two have then fared over time. Red line shows Price while Blue line shows cumulative 12 month Earnings for the 50 companies in the index.
The Calm Investor | Nifty Earnings Growth

What the chart shows:

  • A steady growth in corporate earnings with the odd dip which has coincided with significant price corrections
  • The 2008 credit crisis brought valuations back down to what they were in 1999. Other than that, degree of price changes have been significantly higher than earnings changes
  • Starting early 2014 (around election time), the price levels took off without a corresponding spurt in earnings

Now, here’s a closer look at what’s happened since the beginning of 2015. Basing both Price and Earnings at 100 for Jan 1st. 2015

The Calm Investor | 2015 Nifty Earnings Degrowth

  • As companies have reported their results for FY2015, turns out cumulative earnings have actually declined compared to previous year, and that has been followed by significant drop in markets
  • And in spite of the seemingly steep fall in the Nifty, Earnings have actually fallen even more

Therefore, it’s safe to say that the current correction is only a reflection of poor corporate performance, and as the chart shows, there is a lot of room for that red line to fall towards that blue line. But also keep in mind that if you were comfortable buying in March 2015, you should only be more so in June 2015 after an 11% correction. But if you adopt the time-tested technique of buying regularly without worrying about tops and bottoms, you’ll do just fine.

And to complete the point about the futility of “expert” forecasts:

April 2015: UBS cuts Nifty target for Dec-2015 to 9,200 (link)

June 2015: UBS cuts end-2015 Nifty target to 8,600 (link)

Next time you hear an “expert” hold forth on what markets are likely to do, know that you might as well ask your vegetable vendor and he’d have as much chance of being right

The takeaway for this post is the same as the one I put down in ‘Predicting stock market returns? Not so fast!‘ i.e.

“…whether Indian companies finally start showing earnings growth will be where the rubber meets the road which will decide where Indian markets go in 2015”

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