This Article was originally published in The Global Analyst

Now that Sensex is basking on a bull market (61,000), there are many prophecies on when it would cross 100,000. Of course, the number 100,000 is sensational and represents a milestone for the index and Indian stock market. Hence, the interest to know more on this. Before we dwell into the forecast, let us chronicle the Sensex journey a bit.

In its long history since 1991, Sensex had four distinct phases.

Phase 1: This would be the period 1991 to 2002 where it had only a 5% annualized growth for 11 years. During this period, it limped to 3,377 from 1,909.

Phase 2: This would be the 5 year period between 2002 to 2007 where it catapulted at an annualized clip of 43% reaching 20,000.

Phase 3: The third phase would be 2007-2016 (9 years) where it grew only by 3% annualized limping to 26,000.

Phase 4: The fourth phase is when it touched the current level of 61,000, a period between 2016 to 2021 growing at an annualized clip of 18%.

Observers can easily notice the difficulty already in terms of charting a future course. Will the next 5 or ten years resemble the first phase or the fourth phase?

There are many scenarios possible, but I will restrict it to just three. A base scenario where Sensex’s annualized growth will be its long-term growth since 1991 i.e., 12%. An optimistic scenario would be an annualized growth of 15% while pessimistic scenario would be a growth of 5% annualized. We can now map various milestones like 100,000 or 500,000 or even 1 million through these 3 scenarios. The table below presents the year by which these milestones would be achieved and the number of years of waiting under the three scenarios.

The 100,000 milestone can be achieved in about 4 years under the optimistic case (year 2025) and 11 years under the pessimistic case (2032).

The 500,000 milestone can be achieved in 16 years under the optimistic case (2037) and 44 years under pessimistic case (2065).

The 1 million mark can be achieved in 20 years under optimistic case (2041) and 58 years under pessimistic case (2079).

Now the billion dollar question is which path among the three is most likely. Of course a safe bet would be to anchor on the base case. However, history never repeats but only rhymes. The index performance is a product of two factors i.e., earnings growth and valuation (p/e). Historically during the last 10 years, the annualized earnings growth averaged 6.4% during the last 10 years and during the last 15 years it averaged 7.2%. Countries do break out into high growth phase based on reforms initiative, foreign investment interest and broader economic prospects and growth. If economic growth can be combined with productivity growth (thanks to technology and digitization with youth adoption), then a higher earnings growth of say 10% or 15% is fathomable.

On the valuation side, the 10-year historical p/e (trailing) averaged 23.5 while a 15 year period averaged 22.5. The current p/e for Sensex is around 32, expensive though. P/E expansion happens when the outlook for the country is positive and vice-versa.

Here are the combination of various earnings growth scenarios and the attendant p/e ratios:

If Sensex reaches 100,000 by 2025 where earnings growth is at the long-term average of say 6.4%, then the p/e ratio will shoot up to 40.4 from the present 31.7. Alternatively, if the P/e ratio drops to say 15, then Sensex needs an annualized earnings growth of 36% in order to touch the magical 100,000. A middle path looks more feasible where earnings growth records an annualized growth of 22% while the p/e ratio softens to 23.5 (long-term average) in order to hit the 100,000 milestone.

As much as earnings is the prime driver of the market, it is also useful to look at valuation (p/e) ratio in order to gauge the excess in the market. In order to do that, we constructed the historical evolution of Sensex P/e ratio and applied standard deviation bands where it can be +/- 1 or +/- 2 standard deviation from the mean. We also computed the prospective 3-year and 5-year average return for each of these p/e bands historically. Needless to say that prospective return improves when the p/e band is below the average and vice-versa.

In the past, Sensex never broke beyond +/- 2 standard deviations. However, the recent sharp rise in the index breached that on the plus side meaning it went above +2 standard deviation. Historical analysis shows, that at +2 standard deviation, the prospective return diminishes and vice-versa.

The p/e band analysis shows that Sensex p/e hovered most of the time within the +/-1 standard deviation and very little time in the +1 to +2 standard deviation. So going forward, this should be the case where p/e would fall back to its preferred zone of +/- 1 standard deviation. However, if it persists above 2 standard deviation, then the prospective 5 year annualized return for Sensex can be a negative 0.4%.

Patience is a virtue in the stock market while volatility can be a huge distraction. At 61,000 Sensex may appear highly priced and expensive, which it is. However, even for someone entering at this level, if he can stay the course for the next 5 years (to experience 100,000 Sensex) or 19 years (to experience 500,000 Sensex) or 25 years (to experience 1 million Sensex), the payoffs are good. For a 25 year old person, experiencing a Sensex million at age 50 is not a bad deal though!

Happy investing!