What makes stock markets move?

Aug 14, 2012

In this issue:
» Are FIIs buying or selling Indian stocks?
» Did Indian govt tell us a big lie about this year's rainfall?
» Dollar may continue to be reserve currency for decades
» Will India have to sacrifice growth for curbing inflation?
» ...and more!

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One of Benjamin Graham's most famous quotes goes thus: "In the short run, the market is a voting machine but in the long run it is a weighing machine." That is indeed so true. In the short to medium term, share markets may witness wide irrational swings. But in the long run, share market valuations tend to reflect the true fundamentals.

How do share markets function in the short to medium term? It is important to understand that stock prices usually reflect the future expectations of market participants from the real economy. It may so happen that a bull run commences months before earnings actually show an improvement. Similar, markets may start falling even before earnings show any deterioration. Of course, it is impossible to determine the lead and lag time in such cases. Moreover, the market expectations may not always translate into reality. On many occasions markets are prone to false anticipation.

Do you know one crucial factor that plays an instrumental role in all market rallies and collapses? The answer is financial liquidity. When there's a lot of money into the financial system, bubbles can build up. The opposite is also quite true. A liquidity crunch can bring down markets even when economic fundamentals are strong. But in a globalised world, it is difficult to judge liquidity. FII (foreign institutional investors) money can pour in and flee away at the drop of a hat. A remotely unrelated event in some other part of the world could have an impact on the domestic bourses.

With such wild swings in the share markets, what should investors do? In our view, the value investing technique followed by the likes of Benjamin Graham, Warren Buffett, Peter Lynch, etc. is the best approach to long term investing. Buy fundamentally strong stocks at a discount. Forget where markets are headed. Period!

But it is also true that value investing may not help you in timing your investments too well. And you may also miss out several profitable opportunities in the short to medium. To remedy this, many investors prefer to complement their value investing approach with techniques that help understand market trends and time entry and exits.

Do you think it can be beneficial to use other techniques along with value investing to time your investments? Share your comments with us or post your views on Facebook page / Google+ page.

 Chart of the day
Today's chart of the day shows that Indian equity markets witnessed the highest inflow of FII (foreign institutional investors) funds in 2012 so far. Foreign funds have invested nearly US$ 11 bn in Indian stocks during this period. A significant portion of the funds poured in between January and March and then resumed in July. While FIIs have been net buyers of Indian equities in the current year, domestic institutional as well as retail investors have been net sellers. Among other Asian peers, South Korea witnessed the second highest FII inflows of about US$ 6.3 bn.

Data source: The Economic Times

The much awaited rains have eluded us this year. As all eyes turn towards the heavens for signs of good rains, one wonders if the information on poor rains in India could have been relayed earlier. As per the Hindu Business Line it could have. As reported by the daily, the government could have disclosed this to the nation much earlier than what it did. Instead it chose to keep giving false hopes about the recovery of the rains. Knowing fully well that this was not going to be so at least in this year. Some say the Indian Meteorological Department (IMD) has complex models and systems that are able to give a near accurate picture of what the rains would be like. But another side of the story is that the IMD's models are now outdated and are incapable of predicting weather changes accurately. Whatever it is, the IMD was apparently aware that the rains would fail this year; it did not disclose this information to the country.

As per the daily, this was at the request of the government. But why should government conceal crucial information that affects millions of farmers in the country. What could be the reason for concealing such information? Apparently, it seems that a normal rainfall was the government's only hope at a time when slowing economic growth, high inflation, widening deficits and policy paralysis were taking a severe toll. The news of a drought would only add to the gloom in the economy. But by doing this, the government has only made things worse. Had this information been given earlier, timely steps could have been initiated to assist the agriculture sector.

It was not very long ago when pundits had written off the US dollar as the world's reserve currency. The problem, they argued, lied with the incessant money printing and the trillion dollar debts that Uncle Sam had buried itself under. However, as things stand today, the greenback is still going strong. It has not only survived but is touted to be the safest currency around. So, what changed? Well, it isn't that the fundamentals of the US dollar have improved a great deal. The improvement is mainly because its rivals, aka the Euro and the Japanese Yen have fared even worse. Thus, in what looks like a very bad neighbourhood, the US dollar seems the only safe house.

But how long will this trend last? If an analyst at UBS is to be believed, US dollar's status could be safe for another 50 years. Quite simply because as per him, nothing in the world is as liquid and as widely held as the US dollar. Besides, the dollar also benefits from the military protection the US offers to many reserve holding nations. Well, the analyst's theory does have pretty strong legs to it. And dollar may well remain the reserve currency for many more years to come. However, what we are pretty certain about is the fact that the dollar's devaluation is here to stay. Thus, it will not be a bad idea to keep piling on to that yellow metal called gold.

The Reserve Bank of India (RBI) has traditionally stood apart from its peers. It is therefore hardly surprising that its monetary policies should follow a contrarian route as well. Not just the US Fed, Bank of England and the ECB, but even the Chinese central bank has eased liquidity in recent months. All in the chase of higher growth rates. However, for RBI, the focus has been on curbing inflation. In the past, it did make an attempt to balance inflation and growth rates. But eventually that became impossible. Especially with the government unwilling to cooperate on the debt control front. Hence, the RBI has now decided to let the axe fall on growth rates. Governor Dr Subbarao has emphasised on the necessity to sacrifice growth to tackle inflation. What it means is that the government and the central bank are on tangential directions when it comes to steering the economy. Only time will tell, which of them will succeed in liberating the economy's growth from inflation contagion.

What is China's loss could be India's gain. And this is in none other than rare earth minerals. At present, China accounts for about 95% of the global output of rare-earth minerals. These are used in a range of electronic equipment. However, China in recent times has restricted the export of these minerals through export quotas and taxes. This has pushed up the prices of these minerals. Further, China has set a condition that access to these minerals would be possible if manufacturing facilities are set up in the country. This is where India can step in. It is currently the world's second largest producer with large deposits of rare earth minerals. However, when compared to China, production is paltry. Indeed, in 2010, when China's production stood at 130,000 tons, India's was a measly 2,700 tons. Further, India has other problems in the form of corruption and red tape in the mining sector. In the past, even US produced these minerals but China became the undisputed leader on account of its low cost advantage. Now with prices rising, there is incentive for other countries including India to bolster production. But whether our country will be able to do so remains to be seen.

In the meanwhile, the Indian equity markets witnessed a volatile day of trade. At the time of writing, BSE Sensex was up by 61 points (0.3%). All sectoral indices with the exception of realty, power and healthcare stocks traded in the green. Barring Indonesia, all Asian stock markets too displayed positive investor sentiments.

 Today's investing mantra
"The intelligent investor is likely to need considerable will power to keep from following the crowd." - Benjamin Graham

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2 Responses to "What makes stock markets move?"

M s s murthy

Aug 14, 2012

I have been investing in stock markets since 1982.there were ups and downs but the overall benefit was tremendous .with my past experience I can say with reasonable conviction that long term investment strategy can be compared with ' simple arithmetic ' whereas socalled 'techniques for timing entry and exit stock markets for maximization of profits ' can be compare d with 'rocket science'
I am firm in my openion that what legendary investor Warren Buffet has once said ' that simple fundamental approach rather than complicated calculations will benefit more in the long run' for investment in stoks.

Like (1)

Kersi Mahudawala.

Aug 14, 2012

The value investing technique followed by the different experts is the best approach to long term investing.One should buy fundamentally strong stocks at a discount hold them till the target price is reached and then sell it and make profit.One should not worry for temporary fluctuations in the market.

Like (1)
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