Beware of the (ever-rising) base effect

MUMBAI: With the Sensex having hit record levels of 10000 on Monday, market analysts are predicting volatility in the short-term, but maintain that investors could still make good long-term returns in the Indian markets.

DNA Money has done a study on long-term returns delivered by the Sensex, a portfolio of 30 stocks, as it were, managed by the Bombay Stock Exchange.

Ten-year returns for the Sensex are available from 1989 onwards, since the index was launched in 1979. For the purpose of this study, Sensex levels as at the end of each year have been used.

Absolute 10-year returns between 1989 and 1999 have ranged between 359% and 1,346%, yielding compounded annual average returns of between 16.5% and 30.6%.

Returns from annual dividends would add roughly another 2% to the investor’s annual gains.

While that seems like a decent enough return to consider the equity markets for long-term investing, things are not the same when we look at annual average returns for 10-year periods after 1999.

For the years between 2000 and 2005, absolute returns fell to between 29% and 279%, yielding annual average returns of between 2.6% and 14.3%.

Even at current record levels of around 10000, the Sensex has delivered an annual return of 12.2% in the past ten years.

The only reason returns have fallen this decade is because of what is called “the base effect”.

Growth in the last decade was phenomenally high because of the low levels at which the Sensex was in the decade between 1980 and 1990.

Since Sensex levels had risen rather sharply in the late 1980s and the early 1990s, the higher base has led to a drop in returns this decade.

With the Sensex now at its highest-ever levels, isn’t it likely that returns wouldn’t be too exciting even in the long-term from current levels?

Going by what statistics say about the past, it’s highly likely.