Can 'greater fool theory' sustain Indian stock markets? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Can 'greater fool theory' sustain Indian stock markets? 

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In this issue:
» US lawsuit against rating agency S&P
» Income inequality and wage rise shocks in China
» Bond yields in India remain firm
» China set to overtake India in gold as well
» ...and more!


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00:00
 
Most readers must have come across the story of monkeys that has come to define the US subprime bubble. That a man can fool villagers into selling monkeys to him at higher and higher prices seems funny. But when the person cons them into buying back the same monkeys in the hope of fetching better prices later, we realize the gaffe. The theory that backs such a foolish behavior is commonly called 'greater fool theory'. Ironically, whether applied to US subprime bubble or equity markets anywhere in the world, the core of the theory seems relevant.

As per The Economist, despite sufficient history, the greater fool theory has not stopped displaying itself in various forms. The Indian stock markets and investors here are cases in point. Now fundamentals of Indian stock markets are certainly not disconnected to global slump. Corporate earnings therefore are feeling the pinch of poor global GDP growth. But domestic economic woes including lower growth, inflation, deficits and poor infrastructure have played no small part in thwarting the India story. Even then the stock markets seem to be oblivious of the impending risks.

No doubt few Indian companies continue to maintain their fundamental sanctity. But the greater fool theory seems to be coaxing investors into paying much higher prices for the earnings growth. Only in the hope that a greater fool will be willing to buy the expensive stocks from them later at a higher price!

That the Indian government too is using the greater fool theory to its advantage is no secret. By offloading stakes in PSUs to insurance companies and financial institutions, the government wants to cap fiscal deficit. However the very fact that the valuations of such IPOs and FPOs are not exactly cheap confirms the government's intent.

We believe that the greater fool theory cannot sustain itself forever. Be it Indian investors or FIIs, the realization that the ascent in stock valuations is unreasonable, will be sufficient to scare them away at some point. And investors who try to time the markets might turn out to be the biggest losers in the bargain.

01:35  Chart of the day
 
Late 1990s saw a number of non banking finance companies (NBFCs) convert into banks. As per the Reserve Bank of India (RBI), the number of NBFCs in India reduced from 1,429 in March 1998 to 273 in March 2012. Consolidation in the sector and better regulatory framework for NBFCs has helped the entities become more focused. Capital adequacy and NPA norms have ensured that the NBFCs do not repeat past mistakes. The result is for everyone to see. Barring 2009, the NBFCs have outdone banks in terms of loan growth in 4 out of last 5 years. Given their better penetration and project loan approval skills, we will not be surprised if the NBFCs continue to fare better than their banking peers in growth terms.

Data source: RBI - Macroeconomic and Monetary Development


02:05
 
The ratings agencies have not quite found the going good ever since the sub-prime crisis blew up. And it looks like there is more trouble in store for them. As per reports, the US Government has now filed a US$ 5 bn lawsuit against S&P's and has accused it of defrauding investors. We don't quite understand why only S&P's has been targeted when the other two ratings firms were as much guilty if not more. Well, we believe that the conduct of ratings agencies has been anything but fair. And it goes to the very heart of the US financial crisis. Thus, the lawsuit, despite being a case of too little, too late, does have its heart in the right place. But we doubt anything substantial will come out of it. For nothing has changed to make us believe that the entire ratings process has become saner. The conflict of interest still persists and unless this changes, investors will have no other option but to do their own research rather than take the view of ratings agencies at face value.

Do you think in India too rating agencies should be made more accountable? Share your comments or post them on our Facebook page / Google+ page

02:35
 
Income inequality has become a worrisome factor in most of the developing nations. In some nations like those in the Middle East, income inequality has led to rebellion as well. As a result governments across the globe have started becoming nervous when it comes to growing income gaps. China is no exception to this. Recently it was reported that the country's measure of income divide, Gini coefficient, has gone up. This led its government to put on their thinking caps. It has come up with a 35 point income distribution plan. This plan is aimed at reducing the income inequality in the country. A salient feature of the plan is to increase the minimum wages in the country. It also plans to force state owned enterprises to pay a larger part of their revenues to their employees. China has already started to feel the initial shock waves of income inequality. It is good of the government to wake up and do something about it. Hopefully the plan would not just be another document of empty words and would take material shape soon.

03:03
 
Bond yields are inversely related to bond prices. And 10 year government bonds are increasingly preferred by investors when volatility persists in other asset classes. During such times, demand for bonds and therefore the price increases and the yield falls down. But just recently, India's benchmark 10-year bond yield edged up 0.1% to 7.93%. This was because global crude oil prices resumed their upward trend. And also because some positive economic data emerged from the US coupled with strong corporate earnings. Meaning that there was probably lesser demand for bonds pushing up the yield. The government intends to sell Rs 120 bn of bonds, including Rs 60 bn of the benchmark paper in February. Thus, yields remaining on the higher side could very well be likely.

03:22
 
It is not rare that unscrupulous promoters take small investors for a ride. So there is indeed a need for stronger regulation for listed companies. As a step in that direction, the Securities and Exchange Board of India (SEBI) has tightened listing norms for merged or demerged entities. Here are a few revised norms. Prior to submission of the scheme for sanction from the High Court, a company would have to file the draft along with documents, with the stock exchanges. Moreover, it would be mandatory for such companies to obtain a valuation report from an independent chartered accountant. In addition, the company would also have to include the 'complaints report' in the notice to the shareholders while seeking approval. Also, the listed companies would have to ensure that the scheme provides for obtaining shareholders' approval through a special resolution passed through postal ballot and e-voting. This is surely a step in the right direction.

03:50
 
China seems to be jumping on the gold bandwagon. And it may even surpass India soon. Gold imports into the mainland from Hong Kong surged 94% to an all-time high in 2012. Rising incomes in China helped increase demand. This led the metal to post its 12th year of gains. Mainland China imported 834.5 metric tons (MT), including scrap and coins, compared with about 431.2 MT in 2011. China's urban per capita disposable income rose 12.6% in nominal terms in 2012. Per capital rural net income increased 13.5%. Chinese are becoming wealthier. And this is reflected in their demand for bullion. As the Chinese economy continues to grow, albeit relatively slowly, interest rates remain low, and central banks continue to accumulate, the case for gold continues to be bullish.

04:30
 
Profit booking in mining, power, engineering and commodity sectors led the benchmark indices in Indian equity markets to head closer to the dotted line after a positive start today. The BSE Sensex was trading marginally flat at the time of writing. Other major Asian stock markets closed in the positive while markets in Europe also opened higher.

04:50  Today's investing mantra
"The whole concept of dividing it up into 'value' and 'growth' strikes me as twaddle. It's convenient for a bunch of pension fund consultants to get fees prattling about and a way for one advisor to distinguish himself from another. But, to me, all intelligent investing is value investing." - Charlie Munger

Click here to read our series on 'Lessons from Charlie Munger'
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8 Responses to "Can 'greater fool theory' sustain Indian stock markets?"

shankar

Feb 8, 2013

yes.
we investor when buying stocks, depend on rating agencies rating. however, they repeatedly proved that their very purpose of existence is defeated. take the IPOs the rating given is anything but reasonable. with the result all the IPO retail subscribers lose heavily at all times. they should be brought to book.

Like 

Steve

Feb 7, 2013

INTEREST RATES! That's the ONLY problem with India today!
Drop interest rates by 200 basis points over 6 months and watch the economy take-off......it is foolish to try and tame food and fuel inflation with ever higher gouging interest rates....all you do is to kill the real economy, including manufacturing and exports. It also destroys the Capital Asset Pricing Model on which ALL investment decisions are ultimately predicated.

Fire the fools at the RBI!

Like 

madan

Feb 7, 2013

when same companies were blowing goody goody about your policies, you are comfortable with their views and results,and the movement you feel they are telling something different from what you are planing ,they became the matter of debut,it's very common about the ruling govt.

Like 

SIVARAMAKRISHNAN

Feb 6, 2013

As long as the Country or the people's mood or sentiment and economy is bullied by the financial markets or Stock Market the whole human race will look like a `Greater fool theory' towards the direction of great destruction that started ever since the paper currency, stock market gambling, oil discovery and population explosion have all fallen at the same time or period until now.

The catastrophy is imminent sooner rather than later and it is just a matter of time before the turn of next century.

Like 

Ramamurthi

Feb 6, 2013

NBFCs performance will always be better than the PS banks. PS banks are carrying the old baggage of complicated procedures, which are rid with many loop holes. The employees of these banks have always been reluctant to take risks, which led to less efficient management of money. These banks have HR policies, modeled on the central government rules. This has an inherent disadvantage of not able to get rid of inefficient staff. Being under the influence of politicians their recovery rate can never hope to become sustainable.
Contrary to this are the private banks, who are more efficient. But what I find is they are overstaffed when compared to the NBFCs.

Like 

Madhukar Borkar

Feb 6, 2013

If I understand clearly, the rating agencies carry out their assigning rating job when approached by a party ie Co. on its own volition or another party on behalf of company requiring rating. They do not do suo moto rating and also they do their assesment based on the facts provided by the intending client requring "rating". Therefore, if my understanding is correct, then rating assigned 'to day' may not be valid tomorow, if company does not furnish new facts to the rating agency. So what u have stated "qualify based on your own knowledge/information is correct. At most u can use the assigned rating as an idicator or guidance. - Borkar

Like 

shamsundar

Feb 6, 2013

The rating agencies take in to account past performance and guess the future of the company under various conditions. One thing is for sure: No one knows the future with certainty. Therefore the rating agencies can falter. one shd remember the Coveat in a transaction and shd not go blindly on recommendations.

Like 

Awni

Feb 6, 2013

These RAs think they are holier than the Pope? But they are grossly wrong.They don't have "all" the information about a country and downgrade on simple statistics and some cockney data?

Like 
  
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