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It's different! Oh, is it? - Views on News from Equitymaster
 
 
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  • Aug 11, 2005

    It's different! Oh, is it?

    'This time it's different' are, indeed, the most dangerous words in any 'over-the-top' bull market! It has been observed in virtually all bubbles in the past, be it in commodities, currencies or stocks. In the 'tech bubble', all the 'so-called experts' went over the top, predicting ridiculous things like 'the end of the brick-and-mortar companies' and that the IT companies will keep growing at over 100% for the next few years. In fact, markets were so frothy at that time, that the kind of price to earnings (P/E) multiples that a few IT stocks got were completely eye-popping. Infosys Technologies, the 'technology bellwether', was actually trading at a P/E multiple of nearly 300 at the peak of the tech bubble! Clearly, such ridiculous valuations could never be sustained and all the IT stocks were rudely brought back down to earth with a resounding 'thud' and valuations began to get back to normal!

    In each and every bubble, the 'experts' have some explanation as to why it is 'different' this time around. Each bubble seems to have something that is distinct from the previous bubble to convince investors that, 'This time it's different'. Bubbles represent the triumph of hope and irrational expectations over economic rationality and fundamental logic.

    Now, while we are not saying that the current market is a 'bubble', what we will say is that, at current levels, markets are certainly not 'cheap' anymore. It is becoming increasingly difficult to spot 'value stocks' and 'value' in stocks. Another point to note is that, without exception, each and every adverse event has been summarily dismissed from the minds of the markets and they have just continued on their merry way into stratospheric heights! After the London bombings, the markets briefly lost ground and then immediately rebounded upwards. Even after the floods in Mumbai, where there was irreparable loss of life and property and losses of billions of rupees to the country's financial capital, no less, markets just kept on going only one way - up!

    We consider here, adverse factors in the global economy that 'could' threaten global growth and deflate the 'it's different' myth surrounding the Indian markets.

    Crude oil prices: Crude oil prices have hit all-time highs of late and seem to be in no mood to relent. Early this week, they nearly hit the US$ 64 per barrel mark. Numerous research houses are expecting crude to hit as much as US$ 105 a barrel sometime next year! Yet, none of this has had any impact whatsoever on the Indian stock markets. To compound matters, in July, a platform at Bombay High, India's largest source of domestic crude, was destroyed, resulting in loss of life as well as production of tens of thousands of barrels a day. The effect of these events cannot be underestimated. India's oil import bill will rise significantly this year, due to the big rise in oil prices. This can also have the adverse effect of resulting in higher inflation and putting the brakes on economic growth.

    US interest rates: On Tuesday, the US Federal Reserve raised the benchmark federal funds rate for the tenth time since July 2004 and it now stands at 3.5%, nearing a four-year high. More importantly, the expectations are that the Fed will continue to raise rates at a 'measured pace' in order to keep inflation at bay and maintain the growth momentum in the economy. This rate-raising exercise might continue in 2006 as well. Therefore, this could have the effect of pulling away some of the 'hot' Foreign Institutional Investors (FIIs) money that has come into the markets, which would certainly have its impact on the BSE-Sensex levels!

    There has been an enormous amount of liquidity floating around in the global economy, due in no small measure to the accommodative monetary policies adopted by central banks worldwide. The risk appetite has also increased. Thus, in pursuit of higher returns, this global liquidity flow has found itself being pumped into emerging markets, which have risen by around 13% to date this calendar year. Any reversal of this global liquidity could prove detrimental to these stock markets, including India. At what levels this could happen is anybody's guess.

    The US housing bubble: While the current scenario in the Indian stock markets might not be classified as a 'bubble', the same cannot be said of the US housing market. Numerous reputed magazines and research houses have repeatedly cautioned against what could be 'the biggest bubble in history'. The typical signs of this bubble reflect in the 'castles in the air theory', also known as the 'greater fool theory'. People buy a house, sell it at higher rates and find buyers more than willing to buy at these higher rates. The people who buy at the higher rates, in turn, try and find buyers who are willing to buy at even higher rates, in other words, 'bigger fools'.

    Banks routinely fund over 100% of the cost of the house and it is estimated that as many as 42% of new borrowers are given the loan without any collateral! And to make matters worse, this is a 'leveraged bubble', where buyers borrow money to buy the houses at higher prices, hoping for 'greater fools' to buy them! Once this bubble bursts, it could have ripple effects around the world and the spending capacity of the US consumer, the major driving force of the global economy on the demand side, will be seriously constrained, resulting in a possible slowdown in global growth.

    Terrorist strikes: While markets have more or less factored in the higher risk owing to this reason since 9/11, the impact of this cannot be underestimated. Terrorist strikes in places of strategic importance, such as on a major oil pipeline that leads to a disruption in global crude oil supply, could lead to oil prices spiraling into higher territory and adversely affecting the fiscal health of the country.

    So what's the point?
    It has been reported that Japanese funds have been major investors in the Indian markets since the past few months or so, which is keeping the indices in such high territory. We have heard the stories of the high Indian GDP growth and the 'India story' ad nauseam. But, as we mentioned before, markets have completely discounted all bad news. If this were a bear market, it would have been just the opposite - all bad news, even minor, would have been factored in and would have led to indices crashing!

    At the risk of sounding repetitive, the point is very simple - stick to the basic principles of sound investing. Be disciplined and make sure that you exit if the stock has already hit your target price - which would have been the case in a number of stocks, given the current heady sentiment! Greed is one of the factors that drive markets up. At these levels, caution is most definitely warranted. It is not known as to when the fund flow can dry up and rather than take chances and buy stocks just because FIIs are buying them, it is always better and safer to stick to fundamentals.

     

     

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