It's celebration time, isn't it? - Views on News from Equitymaster

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It's celebration time, isn't it?

Jan 23, 2008

Have you ever wondered why are the days, when Indian stock market crash, termed as 'black' - Black Monday (Jan. 21 2008), or Black Tuesday (Dec. 12 2006, Jan. 22 2008), or Black Thursday (Aug. 16 2007)? At least we do not understand that! The first link from a search on Google.com for the term "Black Monday" will direct you to Wikipedia, which discusses about the 'Black Monday' - a name given to Monday, October 19, 1987, when the American Dow Jones index declined by almost 500 points. Then, lower down the page, there is a link to the 'Black Monday' of 1929 (Oct. 28), which is talked about as 'the terrible day' as it marked the start of Great Depression in the US. This is also talked bout as the day that was a precursor to the worst day in the US stock market history - Black Tuesday, when the US markets tanked 12% in a day's trading.

Coming back to the latest 'Black' Monday and Tuesday (the past two trading sessions) that the Indian markets have just lived, we find many dreams turning into nightmares. Participants, who had followed herds in putting money into anything and everything that was available, have seen their gains evaporate at a quick pace. While one reason that can be attributed to this manic situation is the increased risk of recession in the US economy, the fact that Indian (and other emerging) markets have seen high degrees of irrationality in the recent past cannot be denied. Herds, not fundamentals of companies, have driven investors.

  • We're in 'August' company. Hold on!

    Now, as the US Federal Reserve has cut its short-term interest rate by an unprecedented 75 basis points (0.75%) to 3.5%, participants may well see this as a remedy for curing all the ill deeds that were precipitated by the US central bank itself (as it lent more and more of cheap money to finance subprime borrowers and the unhealthy practices of so many large global banks). The Asian stockmarkets have reacted positively to this rate cut from the Fed. The Indian markets may well behave in a similar fashion.

    But, has the message been passed? Have investors been so adamant as to not learn from the past mistakes, or from the humility that each crash brings with itself? Or is this simply human nature - of not remembering history. We Indians have really been poor in this subject. Ask any student today and you may get to know that the history class is what is the most boring part of a day at school!

    As far as stock market history is concerned, learning has really been poor. Investor irrationality has, more than once in the past, given evidences of how the 'herd mentality' can lead to unfathomable market appreciation without the support of sufficient value in the underlying assets. Such phenomena have led to 'market crashes' that eroded investor wealth and dissuaded market participation for a considerable duration of time.

    It is an oft-repeated scenario in market rallies that investors tend to follow the 'herd' and value a stock beyond any accurate or rational reflection of its actual worth. This creates a situation wherein, once the correction sets in, the majority of investors try to flee the market at the same time and consequently incur massive losses.

    Attempting to avoid more losses, investors during a crash, indulge in panic selling, hoping to unload their declining stocks onto other investors. Some of the biggest stock market crashes in history have been the best 'learning lessons' for investor vigilance - talk about the tulip bubble of 1637, south sea bubble of 1711, great depression if 1929, crash of 1987 or dotcom bust of 2000.

    Such crashes are cautionary admonitions for investors to stay out of irrational behaviour. This is not to say that stocks cannot legitimately enjoy a huge leap in value, but this leap should be justified by the prospects of the underlying companies, and not just by a mass of investors following each other. Take this case - investors, who were pouring money into Indian power sector stocks at 40 to 50 times P/E, fear investing in them at sub-20 levels currently!

    The unreasonable belief in the possibility of getting 'rich' quick is the primary reason people burn their fingers in market crashes. One tends to neglect the fact that there is a direct correlation between high risk and high returns. While the history of market crashes does not in any way foretell anything dire for the future, the best thing an investor can do is keep himself/herself educated, well informed and well practiced in doing research.

    And then, crashes like these must be celebrated and not cursed (by using adjectives like 'Black'), as they present opportunities for investing in quality stocks at attractive valuations.

  • Ajit Dayal's view on stock markets

    So, let the celebrations begin! However, invest in a staggered manner rather then rushing to invest the entire surplus upfront. The stock markets will give you more chances in the future, as the real problems in the US and the global financial system are not yet solved. The pain can still be excruciating, much more than what a 75 basis points cut can cure. But you can survive by not following herds and sticking to quality stocks.

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