• OCTOBER 9, 2003

Caution amidst hype...

Stock markets around the world have been northbound for quite sometime now. However, a closer examination of the major markets in the world would reveal that emerging markets have left their developed counterpart in the shade. To understand the reasons behind these variations in stock market rise, we have considered two stock market indices, the Dow-30 and the NSE-Nifty.

Emerging markets outperforming the developed…
 Dow-30NSE NiftyThailand SET
Last 3 months6.1%30.8%13.9%
Last 6 months18.9%50.2%50.3%
Last 12 months29.3%54.9%62.1%

As can be seen from the above table, NSE-Nifty and Thailand SET have outperformed the Dow-30 in each of the time periods under consideration by a huge margin. In the last three months, while the Dow-30 has grown by a modest 6%, NSE-Nifty has recorded a strong 31% growth. So, what are the reasons for the NSE-Nifty outperforming the Dow-30? To answer this question, we will have to first take a brief look at the US economy.

Like any other economy, the US economic growth rests on three pillars - consumer, corporate and government spendings. Post the tech bubble, the US economy has been growing at a significantly lower rate, which has resulted in high unemployment and high inventory levels. To counter this slowdown and increase consumer spending, the US government announced a US$ 350 bn tax cut in May this year. To add to this, the US government spending, especially in defense, has increased sharply. So, the government has been playing its part in boosting consumer spending. What are consumers doing? Consistent drop in the interest rates has managed to keep consumer spending robust, especially in the housing sector. US consumers have also been buying more of foreign goods, which is apparent from rising current account deficits (in simple terms, imports are higher compared to exports). Corporate investments, on the other hand, have remained low.

Real GDP growth rate (%)
South Korea
Source: Economist

To just put things in perspective, a comparative growth rate in GDP of US with other emerging markets clearly indicates things have not been easy for the US, which accounts for 40% of world market capitalization. This is one of the premises why emerging markets like India have outperformed US. Evidently, fund flows towards emerging markets have shown a sharp spurt in the recent past. While Indian stock market has seen almost US$ 3 bn as FII inflow till now in CY03, one wonders whether the optimism towards the so-called 'FII money' is warranted in totality? As known and experienced in the past in global markets, FII money evaporates as quickly as it came into a country (Mexico and South East Asia in particular).

But this is not to say that the rise we have seen in the Indian stock market is not for real. Obviously, in January 2003, markets were undervalued when compared with earnings prospects. While fundamental correction has taken place with the rise in the last six months, further upward movement would be based on the premise of earnings growth as opposed to valuation correction. In this context, while higher GDP growth prospects for FY04 acts as an anchor, one has to keep in mind that in the long term, expectations and optimism towards fresh money inflows have to be toned down. Whether the Indian stock market will run up by another 30%-40% in the short term of 1 year remains to be seen. The caveat in a galloping stock market is "consider the downside before the upside". Because expectations of earnings tend to be on the higher side when sentiments really turn positive.

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