Will History Repeat?

Looking at the recent correction in stock market, I started looking at historical data for benchmark indices to know how low the stocks could go. I was shocked to see the P/E ratios of indices during bear markets of 1999 and 2003.

The previous bull run of indian stock market started in November 1998 and peaked in Feb 2000 a bull run for around 15 months. The P/E range for this bull run was 11-28. The P/E ratio for Nifty was 10.58 at the start of bull run when Nifty was at 810.85 on 28-Nov-1998 and the bull run ended at a P/E ratio of 28.47 in February 2000 when Nifty peaked at 1756 on 11-Feb-2000.

If you analyze the data for the recent bull run between May 2003 and January 2008, a bull run of almost 57 months, also started with a P/E ratio of 10.84 for Nifty in May 2003 when Nifty was at 936 on 12-May-2003 and ended at a P/E ratio of 28.29 in January 2008 when Nifty was at 6272 on 9-Jan-2008.

After the last bull run the correction lasted for around 19 months and Nifty bottomed on 21-Sep-2001 at 854.2 when the P/E bottomed at 12.3. After that was a time based correction, i.e. Nifty earnings kept increasing but Nifty didn't see that much increase and so P/E contracted and bottomed at 10.84 on 12-May-2003 a time of around 20 months. Thus the total bear market lasted for around 39 months.

Nifty movement

Date	Nifty	P/E	Earnings
28-Nov-1998	810.85	10.58	76.64
11-Feb-2000	1756	28.47	61.68
21-Sep-2001	854.2	12.3	69.45
12-May-2003	936	10.84	86.35
9-Jan-2008	6272	28.29	221.7

The table shows that between 1998 and 2000, the Nifty EPS actually went down. This is in contrast with the current situation when the EPS has grown by 156%. If we assume that the history will repeat but earnings will continue to grow, then after 19 months we can say that at 21.88% earnings growth (which is what we have got over the last 57 months) the EPS of Nifty will be at 303.28. Multiplying this by the last P/E of 12.3, we get Nifty of 3730. This is still 25% below the current Nifty of 5025.

Are we headed for more pain? Two assumptions may change the scenario. Nifty EPS growth which has been only 11% yoy as per Nifty EPS Growth may make things worse since at 10% growth the EPS after 19 months will be 257.8. So at 12.3 P/E Nifty will be at 3171. The P/E may not go down as much as it did last time. It may remain at 15 or more this time due to EPS growth of 21% over the last 57 months. In that case the most optimistic scenario gives 303.28*15 = 4549 which was the recent bottom and the most pessimistic gives 257.8*15 = 3867. Let's see whether it goes to 3171 or remain 4549 in August 2009.