Silly Market Reacts Negatively

bombay_stock_exchangeThe stock market is known for erratic behaviour. After all it is a five sensed dumb operated by six sensed people who are directionless. Despite the good pumping of public funds to boost up the growth in the last budget it nosedived more than 800 points in a single day. But now it is zooming because there is a possibility of disinvestments. Definitely the market analysers don’t have judicial analysis of the budget.

Abheek Barman writes in The Economic Times (21 July 2009)

Despite the crash after Pranab Mukherjee’s big-spending bu-dget earlier this month, India is now the best performing emerging market in the Volatility in the stock markets world. The MSCI India index is up an eye-popping 58% from January. But has anything changed from July 6, when the budget was presented to now, to merit the surge? Practically nothing.

Yes, the government has made noises about disinvestment, a topic that the finance minister skirted in his speech. We’ve been told that at least seven reformist amendments will be brought to Parliament before the session ends. And the finance ministry is trying its best to convince us that the massive Rs 450,000 crore borrowing in the budget won’t all be funded by crisp rupee notes printed by the Reserve Bank of India.

If all these things get done, they’ll help. But remember, disinvestment is a long process. We’ll have to see how much money the government prints and how much fuel that adds to inflation. And the budget session will end on August 7, so the government has two weeks to push reformist legislation through. Clearly investors aren’t responding to reforms or the big macro picture while pumping dollars back into Indian equities.

They’re probably excited by the fact that Indian companies are growing profits faster than anyone expected. So far, about 130-odd companies have announced their first quarter results and the numbers look great: profits are up by a third. But those gains have been squeezed out by cutting costs, not through surging sales. If earnings don’t grow as fast as share prices, the price to earnings (PE) multiple will bloat, setting us up for another crash.

Today the sensex trades a little more than 17 times the earnings of its 30 companies. That’s more than double the multiple of eight that it plunged to in November last year, when the market hit bottom. Today’s PE multiple is not frightening, it’s still lower than the figure of 25 it hit on December 16, 2007, at the peak of the equities mania. But I’m scared at the speed at which the market has run up. Too much, too fast could set us up for another bubble in stocks. And that’s something we simply can’t afford.

Yes, India is one of the great economic stories for the century. Most people agree that it has the potential to grow fast for a very long time, may be for the next 20 years or so. Its population is young and energetic. And there’s no question that India’s appetite for roads, bridges, ports, schools, hospitals and energy will continue until all Indians have a chance to lead a life of dignity.

It’s also true that there are very few countries that offer India’s blend of democracy, courts, diversity and demographics. By sheer chance, India was colonised by the British and not, say, by the Dutch or the Portuguese. That chance happening made sure that many Indians speak and write English, something that’s useful when English has become the dominant language for science, technology and business.

But that’s the long-term story, and we know that financial investors — pressed to show returns every quarter — don’t get in and out of markets for the long term. Ultimately financial investing is all about buying into companies that promise steady revenue and profit growth. Today, we’re seeing faster than expected profit growth, but the topline moves sluggishly. Slow sales growth means only one thing: demand is growing slower than expected.

That’s supported by another piece of evidence: from December 2008, when economies tanked the world over, to May this year, India’s imports have been contracting. Now, imports measure the ability of India to absorb goods and services from all over the world. If that’s in negative territory, then there’s certainly been a slackening of demand in the economy. Sure, commerce minister Anand Sharma says that the rate of decline has slowed, but neither Sharma nor anyone else can predict when demand will bounce back.

Demand is slack in India. Demand is falling in many parts of the world. Meanwhile, there’s a giant wave of cash that’s building up, ready to turn into a tsunami of funds. These funds will flood into any market that looks better than the rest.

For example, China’s printed 28.5% more money from June last year, to June this year. The US has forked out tens of trillions of new dollars to restart its economy. It’s the same in Europe and Japan. And our government has promised to spend a whole lot more to make sure growth doesn’t stop.

So, there’s a lot of money in the system. Right now, this money is going to restore confidence, shore up banks, mend financial systems, and get people to spend. But soon, there’s going to be a very large amount of money chasing too few good assets.

If you look around the world, India looks very attractive: low risk, low exposure to export markets, around 7% growth, and a regulated — but relatively safe — banking system. So, I fear, India is going to be one place where this funds tsunami will head. We’re seeing the first breakers from that wave hit us. That’s probably why we’re seeing markets run up so much, so fast.

That is the most plausible explanation that I can find for a more than-100% jump in the sensex’s PE multiple. What that means, essentially, is that the gap between the price of a share and the profits earned on that share has widened more than twice, from eight to 17. You could argue, quite reasonably, that the lower number was a product of unnatural circumstances — the fallout from the worst crash in living memory. Point taken, but the recent run up has happened at terrifying speed, as the Indian market has raced up within eight months of its recent lowest ebb.

Can policy help? Unlikely — and probably undesirable — as any action by the government to stem the tide of money coming in could cause investors to turn tail. That in turn could create further problems with exchange and interest rates and foreign currency reserves.

But there’s hope. If the tsunami of money breaks up into smaller waves that hit different countries around the world, the impact on India will be less severe. For example, a lot of the money will flow towards China, a lot of it will head our way. But as the US and Europe emerge from their troubles, investors will find value there as well. Everyone loves a healthy, growing market. Recent experience has taught us to be very wary of irrational run-ups.


1 Comment

  1. +00002009-07-21T17:45:34+00:00312009bUTCTue, 21 Jul 2009 17:45:34 +0000 2, 2008 at 7.27 p07

    You have sensed it rightly, the Indian stock markets will boom like any thing, the PE discounting will be far beeter over and above the improved performance on profit front and that would take the Sensex/Nifty to new highs in about a period of 16 to 30 months (in fact earlier but you have say in manner that people digest.

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