Five Things about the Market Crash That No One is Telling You - The 5 Minute WrapUp by Equitymaster
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Five Things about the Market Crash That No One is Telling You

Jan 8, 2016
In this issue:
» New challenge for Auto manufacturers
» 'Make in India' Journey so far
» The stocks that have destroyed shareholders wealth
» ....and more!
00.00
Tanushree Banerjee, Co-Head of Research

Global markets are shivering after China's sneeze. Every media is giving you data points about how China's market meltdown is just the tip of the iceberg. That there is a lot more pain to come. We are not sure if this is as bad as 2008, as George Soros claims. But as Rahul wrote to you yesterday, there is every reason for Indian investors to prepare for a bigger crash.

If you are not convinced, here are five critical things about the market crash that no one is talking about.

  1. Raging global currency war in the midst of economic crisis

    Reserve Bank of India governor, Raghuram Rajan, has a track record to envy when it comes to predicting crises. He predicted the bubble in US subprime, at the risk of inviting Fed chief Greenspan's wrath, almost two years prior to the market collapse. So now when he is warning of a possible global currency war, policy makers and investors could not take him seriously at their own risk.

    The RBI governor certainly does not see much of a gain in achieving a country's macro-financial goals by depreciating its currency. But he might have no choice if India's competitors (read China) do that to stay afloat in these uncertain times. Even though managing currency risk is not the RBI's key mandate, it may have to intervene if global central banks continue to threaten on a currency war in 2016.
  2. Regulatory misgivings another reason for crash

    Few of us know that the misgiving of the Chinese market regulator was also to blame for the recent crash. My colleague Apurva Sheth, Editor of Swing Trader recently explained why the Chinese regulator's actions were fundamentally wrong. Here is what he wrote in The Daily Profit Hunter.

    Chinese markets had to be shut for trading on Wednesday after the Shanghai Composite Index hit the circuit breaker limit of -7%. The China Securities Regulatory Commission (CSRC) introduced a two-part mechanism to tame the drastic volatility on 4 January 2016. As per this mechanism, the circuit breaker halts exchanges for 15 minutes after a 5% drop in the index and then halts them for the rest of the day after a 7% fall.

    The CSRC may have implemented this mechanism with good intentions of protecting investors from volatility, but this rule is doing more harm than good. The problem here is that the circuit limits set by the regulator are too narrow. Chinese markest are generally considered to be high beta in nature. A 5% move either way isn't abnormal for Chinese markets, especially during a crisis such as the one China is going through now.

    The worst part of all this is that the Chinese regulator has got it all wrong at a much deeper and a fundamental level. They implemented this rule in anticipation of a short-selling ban, but it was supposed to be lifted on 8 January 2016. The regulator expected that lifting this ban would invite short sellers, so it was necessary to limit the extent of a fall.

    By banning on short selling and implementing a narrow circuit breaker, the regulator is blocking the natural flow of markets. With these policies in place, the regulator is not facilitating its primary objective of efficient price discovery. They are missing some fundamental rules of how markets operate.

    Markets exists only because there is a difference of opinion. For every buyer there is a seller and for every seller there is a buyer. Markets cannot operate without both parties. A ban on either of these activities (buying/selling) is silly.
  3. China's debt is scarier than its stocks

    If the stock market crash was China's only problem, it might not have been a reason to be so worried about. As Bloomberg points out, bubbles are less damaging to the real economy when they mostly involve equity rather than debt. Debt crashes inflict harm on the financial system, creating major recessions that take years to repair. Equity crashes, meanwhile, merely reduce paper wealth. A good example of an equity bubble that wasn't very harmful was the late 1990s US dot-com boom. When it ended, stock prices were devastated, but the crash led to only the mildest of recessions.

    The problem with China is that the stock market crash appears to be the most visible sign of economic crisis. But the bubble in China's inflated debt market and shadow banking system is a gargantuan risk in comparison. So the crack is expected to be much deeper than anticipated.
  4. Small and microcap stocks at 52 week highs when Sensex at 52 week lows

    A team member who works with Richa on our smallcap recommendation service, Hidden Treasure, sent an interesting statistic last evening.

    He told us that even as the BSE Sensex is at 52 week low, there are 260 stocks trading at 52 week highs on BSE! Out of them, only two belong to BSE-A group. In other words, while bluechips stocks have shown sharp correction in response to Chinese market crash, the smallcap space remains frothy. Hence, while you may want to live up to the 'greedy while everyone else is fearful' mantra, we would recommend that investors should be extremely selective about the quality of stocks and not just the valuations.
  5. More pain and growth pangs in the offing for Indian investors

    It will not help investors to get complacent about evaluating the risks to the Indian economy as well. True, the health of our financial system is not as perilous as in the case of China. Thanks to RBI. But there is enough to worry about, despite the fact that we are now growing faster than China.

    Vivek Kaul writes in his Diary today...

    In the Indian context the tendency in the recent past has been to look at economic growth (GDP growth), which has been higher than 7%, and say that we are the fastest growing large economy in the world. Another version of this tendency is to say that we are now growing faster than China.

    The trouble is if we were to look at 'real' data points (or the Indian version of the Li Keqiang index), the economy looks clearly to be in a weak territory.

    We might be the only bright spark globally when it comes to economic growth, but we are clearly not growing as fast as is being made out to be.

If this is not enough the problem of bad loans in Indian banks is a huge overhang over the economy's stability.

Thus, while long term investors may want to salivate at the prospect of buying solid stocks cheap after market crash, do not be in a hurry. Take all possible risks into account and do not try to satiate your stock buying appetite at one go. There are certainly more such crashes coming our way!

What are the risks other than China's market crash that you are looking at? Let us know your comments or share your views in the Equitymaster Club.


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3.15 Chart of the day

As is quite evident from this chart, the companies that have eroded investor wealth since 2008, had very little fundamental support to back their stellar valuations. Investors' buying decisions in these stocks were largely driven by investing fads during the market highs of 2005-2007. But as companies failed to justify their valuations with earnings growth, the euphoria wore off. As a result, such stocks eroded investor wealth by more than 90%.

Stocks that eroded shareholder wealth

3.45

Apart from the global pressures, the Indian auto manufacturers seem to be engulfed by regulatory challenges too. The government recently announced its decision to prepone the timeline for enforcement of Bharat Stage VI emission norms (from existing BS IV norms). The new norms will be effective 2020. This is one year earlier than scheduled date in 2021. This move is expected to increase the prices of petrol as well as diesel vehicles, making them more expensive. This event too, spooked investors and led to sharp correction in the stock prices of auto companies.

As reported in Business Standard, the market caps of six leading auto companies were eroded by almost Rs 20 bn in a single trading session, yesterday.

Just few days back, we had warned investors how regulatory concerns could impact auto manufacturers in an edition of The 5 Minute WrapUp.

While there is still merit in buying some of the best businesses in the auto space, investors should not undermine the risks to growth and profitability.

4.15

An article in Firstpost outlines some key developments that took place in the last one year since PM Modi announced the Make in India campaign. Many MNC companies like GE, Hyundai, Honda, HTC, Lenovo and others have shown interest in manufacturing or investing in India.

These developments are certainly quite encouraging. But is India prepared to reap the fruits of these developments?

The biggest challenge persists in commencing the investment cycle , which has failed to pick up. This is partly evident in the quarterly earnings of the companies. The past few quarters have been subdued for most Indian corporates.

Over and above, the infrastructure, power and industrial sectors still need to be revived. Large number of projects remains stalled since many years now. So while the intent may be there, the execution of big ticket reforms and its impact on corporate earnings leaves a lot to be desired.

4.45

After opening on a flattish note, the Indian markets have witnessed selling pressure and are trading well below the dotted line. At the time of writing, BSE Sensex was trading lower by about 296 points. All the sectoral indices were trading deep in the red with stocks from software and banking sectors facing the maximum brunt.

4.50 Today's Investing mantra

"Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst) and Bhavita Nagrani (Research Analyst).

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Equitymaster requests your view! Post a comment on "Five Things about the Market Crash That No One is Telling You". Click here!

1 Responses to "Five Things about the Market Crash That No One is Telling You"

Krishna Murthy

Jan 10, 2016

Sri Tanushree BanerJee

Her article is very good. Educative and cautioning. Given the Raghuram Rangarajan,s view are 100% correct. The main culprit is the UPA govt and its bureaucrats with out any respect for the economy spoiled the country,s economic safety. Ultimately their shit is pasted to common innocent people of this country. The rural farmers suicide is direct cause of their shit. Urban people and their livelihood depends on the govt dole and bribe, hence not much suicide is reported.

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