A colour code to decode the markets? - The Honest Truth By Ajit Dayal
Investing in India - Honest Truth by Ajit Dayal
A colour code to decode the markets? A  A  A
30 MAY 2013

The stock market is a strange animal.

Some days it charges full steam ahead like a born-again Finance Minister keen on reforms. Then on some days it wilts towards oblivion like a Prime Minister in purdah.

In some years the markets give you spectacular returns and in some years the market hands you significant losses.

Many times, the shares you bought - or the mutual fund you invested in - never seems to do as well as the "market", represented by movements in the BSE-30 Index or the NSE-50 Index.

It slowly dawns on you that this is a rigged industry. The spot-fixers in the IPL may be caught and punished, but the fixers in the financial service industry will never be caught - that is because they are friendly with governments, regulators, and policy makers - globally. For a better insight into this spot-fixing activity in the financial services industry, please see these two highly enlightening - and scary - films:
(1) The Inside Job, and
(2) Capitalism - a Love Story.

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Calming and soothing voices

Often, a Finance Minister will issue a statement comforting us with words like: "There is nothing wrong with the stock market. It is falling for some unknown and unnecessary reason. Don't panic. Everything will be all right."

But rather than giving me comfort to know that the daily twitch of a stock market is not a sign of sure death, I am more concerned that a Finance Minister has to even worry about the daily movement of a stock market. Which leads to the obvious follow on question: will any Finance Minister advise us when it is time to sell out of the stock market? Will we be told that the stock markets are too high and it is time to book profits?

SEBI, as the regulator of the capital markets, has a perpetual mothering role over the stock markets. Over the past 25 years, SEBI has presided over a system that has become more efficient - as measured by the cost of doing a transaction. In 1994, your friendly broker earned 2.50% as a broking commission from you to transact in shares. In 2013, they will be lucky to earn 0.25% from you in broking commissions. The 90% reduction in cost of transacting in a stock has been a great win from the investors' perspective. Hats off to SEBI, the stock exchanges, and the depositories for making this happen.

But, though the known costs of transactions have declined, are investors better protected from malpractices by founders of companies and by the financial intermediaries? Recently, the regulators seem to be willing to take on some of the most powerful and well-connected business groups and punishing them for their alleged wrong actions.

In 2002, SEBI banned broking house and FII, Credit Suisse from participating in the capital markets for 2 year with effect from 2001, when their broking license was suspended.

In 2009, under the Chairmanship of Mr. Bhave, SEBI banned the payment of upfront commissions to distributors by mutual funds to prevent the repeat of the massive mis-selling that took place in the 2005-2007 boom years and entrapped millions of investors into products that were not suitable for their portfolios - but very suitable for the compensation packages of CEOs of the mutual fund houses and their distributors.

In 2011, under the Chairmanship of Mr. Bhave, SEBI passed an order that restrained Anil Ambani and four of his executives from investing in the stock markets for one year. Two ADAG

companies (Reliance Infrastructure and Reliance Natural Resources) were also restrained from investing in the stock markets for two years and had to pay a fine of Rs 25 crore each.

In 2013, under the Chairmanship of Mr Sinha, SEBI's case against Sahara group has led to a Supreme Court judgement to return Rs 24,000 crore to its depositors and investors.

In 2013, under the Chairmanship of Mr. Sinha, SEBI fined a subsidiary of the Mukesh Ambani controlled Reliance Industries Rs 11 crore for an insider trading case relating to trading of shares in the year 2007 in IPCL which had generated a profit of Rs 3.82 crore.

Some pretty powerful hits there.

The sceptics may argue - correctly - that the fines are sort of meaningless and will not discourage the perpetrators from repeating the alleged crimes. Worse, the soft kisses on the wrist for these episodes could inspire the sharp (but convoluted) Indian mind to work out that the potential cost of a possible fine is far lower than the actual profit from an actual violation! Violations, therefore, will increase! But something is better than nothing, in my opinion: actions have been taken and a red flag has been raised. Investors have been warned not to flirt with possible danger.

SEBI is also trying to make it easier for investors to vet products.

To help prevent the disease of bad IPOs from hitting the wallets of investors, SEBI has put in place a scoring system. I don't think this is a reliable indicator but time will tell.

Recently, there was a colour coding of mutual funds - a similar concept to the scoring system of IPOs to help investors decide where to invest. Again, I don't think this is a reliable indicator but time will tell.

A simpler code to decode the markets?

So, with all this nurturing and all this brilliance from the members of various committees which have advised the Finance Ministry and SEBI over the past twenty five years on so many reforms, the question remains: why are less people buying shares?

In fact, why are millions of people getting out of stock markets and mutual funds?

The answer, in my opinion, is due to two factors:

  1. While SEBI may be taking on some of the untouchable giants, there is still a massive amount of distrust of the government, SEBI, the intermediaries, and the business houses. An investor may have lost 30% of his savings in mis-sold products. The fine on the intermediary - or the founder of a business - maybe 0.0001% of their annual profits. And then they live to cheat another day. Intuitively, the investor knows that the system is still not in his favour: the investor's loss is far greater than the loss that may be imposed via a fine on the guilty.

  2. Stock markets are not an easy investment to understand. The wild swings for no apparent reason draw a lot of pauses, ums, uhs, and perplexed nods from the "experts" who occupy so much of the media noise. They look clueless because they are clueless. If all these high-paid, supposedly knowledgeable people have no clue on what is going on, how the heck is a simple investor supposed to know what to make of the market? And every investor has many alternatives for their savings. In addition to all the tax-exempt products, alternatives like fixed deposits are easy to understand. There is a clear and defined money-in and money-out relationship. Property is also easy: you can touch it, though there is a risk you may end up owning air if the developer is a crook. Gold is even easier to comprehend to a typical Indian.

  3. You can see it on your wife's neck every day and you know you will need some for a wedding in the family one day!
So, while SEBI is taking on the difficult job of cleansing the market, here is a simple grid to understand why stock markets are moving up - or down.

You don't need a statement from the Finance Minister to explain the movement.

You don't need the regulator to tell you what they are doing about "fixing" the market.

And you don't need to spend hours watching people repeat senseless statements on TV channels.

All you need to is common sense and some basic information culled from what you read to decide if the markets look attractive or not for you to invest in.

Table 1: In simplicity, find your guidance?
Flows from foreign investors are increasing Be careful, markets are likely to move up for the wrong reason. They should move up because earnings of companies are increasing, not only due to flows! Markets will rise: maybe too fast, too soon. Enjoy the appreciation in your investments from shares, but look for the next "cycle" of lower flows or lower earnings - both are bad for the future!
Flows from foreign investors are flattish - or even falling Markets will fall, be careful. As a long term investor you should be happy and try and invest more! Markets are weak and falling because no one wants to buy stocks. But the earnings of companies are growing - and that is the main reason to buy stocks in the long term.
  Earnings of Indian companies are not likely to grow, maybe stagnating or even declining Earnings of Indian companies are likely to grow
Source: Common sense and experience?

Stock markets are indeed a complex place - but investing need not be complex.

We yearn for simplicity to "decode" them: a number, a score, a rating, a colour code for a mutual fund, a ratio, a simple grid (like the one above?)....

Some of these simple tools will work - and some will fail miserably.

Maybe in future, the Finance Minister will refuse to make a comment on market movements and, instead, refer investors to this grid. Simply.

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Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site. To write to Ajit, please click here.

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3 Responses to "A colour code to decode the markets?"


May 31, 2013

As usual, an excellent post by Ajit. All the more reason to focus on a stock's fundamentals due to vagaries of the market-- Indian market is entirely controlled by the FII's who panic at the slightest hint of uncertainty so we should expect more swings in the coming days, at least until the next elections. This only strengthens the case for Value Investing, especially in the Indian context where politicians,and corporates make strange bedfellows.. regds


sunilkumar tejwani

May 30, 2013

the honest truth! stock market is a rigged entity is known since ages. the worst part, the finance minister is trying to stage manage it. Only a handful of expensive stocks (read fancied A group/Index stocks) have been moving for a while, when the broader market has not moved in tandem. so what, ground reality is the same: earnings growth has been mediocre or at best due to non operational reasons of the fancied stocks. In some cases, certain stocks have gone to the over valuation / sky high P E multiples, and are still rising. Fundamentals do count, but not at the expense of expensive valuations and incessant money flow of F I I or round tripping of Indian Money via F I I route.
God save our Indian Stock market when the regulators are fiddling.

Like (1)

Eric Pinto

May 30, 2013

Took you so long to realise the markets were being fixed ! We knew that all along and you should have told us so long ago !And do name the big players that SEBI is after. The SC is also after them but not a squeak from the media. And that includes The Honest Truth .

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