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Why are the equity markets falling? - Views on News from Equitymaster
 
 
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  • May 18, 2004

    Why are the equity markets falling?

    Markets go up. Markets go down. Now they are going down? Why?

    A. Well, why did stock markets rise - globally? Let’s see…there were many reasons.

    1. Firstly, the Iraq war and the fear of SARS made investors out of equity assets till March, 2003 – all over the world. So, by April 2003 when SARS faded away and the Iraq war was “won” money came pouring back to equity markets – globally.

    2. Low interest rates around the world and continuing consumer spending in USA allowed the companies worldwide to lower finance charges and increase profits. When profits increase (when they are not expected to) investors’ turn optimistic and bid share prices up – globally.

    3. Also, with low interest rates many hedge funds were able to play the arbitrage game: they could borrow in US$ at low rates of interest and then invest that money anywhere in the world where they expected to get better returns. Some of that money came into emerging markets like Brazil, China, and India.

    B. Why did the Indian stock market rise? For many reasons.

    1. Firstly, because of money flows from the FII’s (see the 3 points listed above). The FII’s invested about US$ 10 billion in the past 12 months. That is about as much money that UTI has under management. Imagine the power of adding one UTI to the Indian stock market: it created a demand and supply imbalance. The demand for shares was more than the supply of shares. When demand is more than supply, prices increase – that is basic economics.

    2. Part of this is the additional demand of shares from foreign investors who are buying Indian stocks outside India. No one knows that amount. No one tracks it. The foreign investors gain exposure to the Indian market via “Participatory Notes” which is captured in the statistics. The foreign investors use this P Note route as they do not wish to register with SEBI nor get involved with the tax implications in India. There were frequent changes in policy and attempts to control this but, most likely, with the sale of government shares and an expected increase in the supply of new shares the rationale and reason to retain the P Note route was considered to be a good decision.

    3. But there were also real reasons to support some of the rise in share prices. Company earnings were good, the economy was doing well, the ruling NDA-led government was expected to win the elections, etc. These are fundamental factors that generally support the increase in share prices.

    C. Now why are share prices collapsing?

    1. Well, they are collapsing globally. Interest rates are increasing in the USA and this makes it difficult for many hedge funds to borrow cheap and buy shares around the world or even in their home countries. Before the Indian markets fell, Brazil and China were already down between 20% and 30% from their recent peaks. In Indian terms, this would mean that from the peak BSE-30 Index of 6,100 levels, the market should have been between 4,300 and 4,900 to be “equal” to the fall of Brazil and China - assuming that there is no specific India-event that affects the perception of local and foreign investors.

    2. Investors are getting increasingly concerned about geo-political risk and changes in government, not only in India, but also in Europe and USA in their up-coming elections. And they have decided to book their profits and reduced their exposure to equities for a while.

    3. India is suffering now from the after-effects of relying on one kind of buyer: the foreigner. While the foreigner was buying, everyone was happy and telling us how India was shining. What people should have started to worry about was the effects of these same buyers (whether on the Indian stock exchanges or via P Notes) turning sellers. And we know, or should have learnt by now, that every buyer one day becomes a seller: that is the law of markets and market cycles. Now the foreigner is selling, and the markets are tumbling because there are no buyers to absorb all that foreign selling.

    4. India is also suffering from “the shock” of the NDA not winning. That is an India-specific event, not linked to other global events (like China wishing to slow down its economy, USA raising interest rates, the leader of Iraq’s Governing Council blown up in a car bomb attack). No pre-election poll predicted it, no equity strategist expected it and even the winning party did not expect it!

    So, who should I blame?

    1. The stock exchanges for having a stock exchange?

    2. The foreigner for buying, and for now selling?

    3. Local speculators who exaggerate market movements on the upswing (by buying ahead of the foreigners) and on the downturn (by selling ahead of the foreigners)

    4. The US central bank for indicating that it could raise interest rates?

    5. The previous government for making us believe we were shining and happy that the rising Index was an approval meter of their policies?

    6. The Left Parties for saying what they have always been saying (which is why they are called “Left”)?

    7. The pollsters for not predicting the election results?

    8. The new PM, Sonia Gandhi, for winning?

    9. The people who voted her in?

    We love to blame others, so the list above is an indicative one which you can add to and modify depending on whether you are pro-Sonia , pro-BJP, or pro-whoever. Or should we, instead, take this 12-month sharp rise and fall in the markets as yet another lesson (having gone through many before, including the recent tech bubble of 2000) that investing in shares is a risky business and one must be disciplined about it or find a disciplined advisor to make you a decent rate of return as opposed to gambling away on the stock market?

    Oh, yes, before I end with these thoughts from a hotel room, another word of advice. The market will rise again - with your money or without it. I don’t know when and I don’t’ know by how much or for how long. But I know it will. So, if you had discipline and kept your fear and greed and other emotions away from your decision-making process, you would invest (not speculate) while others are selling. I know I am investing.

  • "The buying opportunity has begun…" Read Ajit's view on the stock markets.

     

     

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