It's not just politics, stupid! - Views on News from Equitymaster

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It's not just politics, stupid!

May 19, 2004

Equity markets in India stand numb, still trying to come to terms with what has happened over the past three days. In light of the current round of debacle in these markets, let us examine the responses received for a poll conducted last week on our website. We had asked our viewers the question as to what, according to them, was the key reason for the stock markets to fall so drastically. The responses are summarised in the graph below.

Almost unanimously, about 93% of those who cast their vote, polled for political concerns to be the biggest factor behind the market fall. The other two factors, i.e., oil prices and terrorism, polled a mere 6% and 1% votes respectively. Let us discuss the three factors in detail.

Political concerns
In line with the audience view, we believe that the present fall in the stock markets is largely a reason of concerns on the political front. However, what is more important to note here is that the effect seems to be overblown. Even when the new government has not assumed its responsibilities, the markets seem to be extremely depressed. While we believe that politics do take the precedence in the top-down approach to investing, over the long-term, fundamentals are likely to play an important role in determining returns to investors.

The importance of politics emanates from the fact that government policies have a very strong impact on the performance of all the three constituents of a country's output - agriculture, industries and services. This further affects investment decisions, as investors are generally apprehensive of an unstable government. The current stream of events in Indian politics and the consequent effects on the stocks markets bear testimony to this fact. Almost suddenly, fundamentals have been forgotten! Almost suddenly, yesterday's crown companies have no takers! This is indicative of the degree of effect that stability in politics has on stock prices.

Oil prices
Hardening crude oil prices is another important reason for the recent downfall in the stock markets. However, since politics has taken precedence over everything else at present, this concern has not been given due importance. If crude prices continue to rise, it may culminate to rising inflation in global economies, especially in those (like India) that are highly dependent on oil imports. This may then lead to the central banks changing their stance from soft interest rates to increasing them to bring about price stability (inflation control). This rise in interest may then slow down the economic growth that seems to be showing signs of sustenance after the last couple of years of slowdown.

As we had said in an earlier article, terrorism has been one of most serious concerns that has shadowed global economic growth over the past few years. First it was the September 11 attack in the US, then it was the Iraqi conquest by the Americans and then it was bomb blasts at Madrid. All these events are indicative of the danger of terrorism rearing its head time and again. India has had its share of the same as well (attack on the Parliament in 2001 and last year's bomb blasts in Mumbai). Terrorism not only leads to loss of innocent lives, it also brings economic activities to a grinding halt.

We will like to reiterate here that investors should not consider only political uncertainty as the perpetrator of their losses. There are several other factors playing very important roles in determining the pace of global economic growth and, consequently, returns for investors in equities. However, while factors like political uncertainty are more likely to have a medium-term effect, others like terrorism and interest rate rise are likely to have long-term bearing.

In that case, a staggered and a long-term strategy is most likely to be successful in providing investors with adequate returns on their investment. However, in these times of high levels of political uncertainty, we advise investors to practice a wait and watch policy and do not fall prey to the overall chaos. After all, as someone said, "The only problem with a rat race is that, even if you win, you are still a rat."

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