Learnings from the harrowing fall - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
Learnings from the harrowing fall A  A  A


The recent harrowing fall has shaken everybody for both its suddenness and its depth. Between Jan 10, when the BSE Sensex peaked at 21,206, and Jan 21, when it fell to 15,332, it has lost 27.7% in just 8 trading sessions. The India story no longer seemed quite so strong, in the face of a global meltdown, to both domestic and foreign investors. Foreign investors exited with great speed, contrary to the belief that India, being one of the growth stories with GDP growing at 9%, would attract larger allocations. It is said that those who forget the lessons of history are bound to repeat them; so one should try and pick up learnings from the fall.

The US matters. With over 40% of the global economy, what happens in the US affects the rest of the world. Over time, perhaps, China and India may take a larger slice of the global economic cake, and may, perhaps, decouple from the US, but right now we are umbilically tied to it. So Indian investors must pay attention to what is happening to the US economy and can't afford to be blasť about it.

The US economy is consumption led. Policymakers, therefore, encourage consumption to such an extent that consumers spend 106 if they earn 100. Taking of credit is highly encouraged, which is the epicentre of the current problem in the form of subprime loans. Deepak Parekh describes these as ninja loans, or loans to those with no income, no jobs or assets. Borrowers were teased with zero interest for the first few months, followed by a subsequent reset to a higher rate which they obviously couldn't pay (unless property prices kept rising, in a sort of ponzi scheme). Banks which provided these loans have taken a huge hit but, importantly, there has been a dramatic slowdown in lending as the worms are still not completely out of the woodwork. Interbank lending has slowed as no one knows which bank will next be hit. This is why the US Fed (combined, for the first time ever, with Central Bankers of other countries such as ECB) tried to pump money by lowering rates. The US Fed reduced its rate by 50 basis (0.5%) on top of a 75 basis cut recently announced.

Now, if a doctor sees the haemoglobin level of a critically ill patient failing to respond to successive transfusions of blood, he would get worried. Similarly, the failure of stockmarkets to respond to transfusions of money is a worrying factor. Thus we are not quite sure if this latest monetary injection given to Uncle Sam by Doctor Bernanke would restore colour to his cheeks. One suspects not. The US has pushed up its standard of living too high and is unable to earn enough to maintain it, because almost in all the industries in which it had a competitive edge to enable it to get a value add, are now seeing global competitors whittling that edge. The auto industry has faced competition by Germany, Japan, Korea and, now, perhaps, India. The electronics industry has moved to Korea, Japan and China. Commercial aerospace is shared with France. IT has moved to India. In Defence and military technology the US retains a commanding lead. The US will have to find the new new thing that will provide it with a competitive edge which may be in the fields of genomics, robotics or nano technology.

If one were to analyse the speed of the meltdown, one could conclude that it was, perhaps, the combined effect of institutionalisation and the altered nature of retail participation in the speculative segment. Mutual funds and foreign institutions often behave in a herd fashion, which exacerbates the fall. By law, equity mutual funds are not permitted to keep more than 15% of their money in cash. As a result the selling decision is taken away from the fund manager, who is better informed and qualified, and into the hand of the investor. This is wrong and SEBI should study if this factor caused a faster meltdown and give, if confirmed, a greater elbow room to fund managers to exit in anticipation of falls rather than only when redemption pressures demand it.

The FIIs moved out, sometimes, to cover losses elsewhere. Citi, for example, is looking for buyers of its stake in HDFC simply because it has lost tons of money in the subprime fiasco and not because HDFC's performance is bad.

Also responsible for the speed of the crash was the changed nature of retail participation in the speculative segment. When the erstwhile 'badla' system prevailed, there was an adequate retail participation as everyone understood the system and because short sellers were compensated for taking the risk of shorting, by being paid a 'badla' or contango charge. This was replaced by the F&O segment. Now the safer O (options) segment has not been developed, though it has been introduced. Quotes are so ridiculous that there is little money left on the table for any trader with a view. SEBI must take steps to develop the options segment to increase volumes and reduce spreads, thus encouraging retail participation. In the absence of sensible quotes, traders move to the F (futures) segment, where the 'mark to market' practise led them to grief in this sharp fall.

The speed of the banking system lags far behind the speed of the trading and settlement system. It takes 3 days to clear some inter city cheques. Thus, even where margin cheques or purchase-for-delivery cheques had been received by brokers, the slowness of clearing led to broker terminals getting shut. So other clients of the brokers, willing and able to buy, were prevented from buying. Without buying, the market fell deeper than it should.

SEBI, alongwith Stock Exchanges and RBI, must look into how the slowness of the banking system is causing a problem in capital markets and find ways to prevent its recurrence. There is an RTGS system that, for a cost, provides instant credit of cheques to the recipient, perhaps greater use of this, for larger transactions, could be encouraged or even mandated. There must also be a proper segregation of margin account paid by investors to brokers and a system to ensure these are not misused. It was misuse of margins by brokers that led to the abolishment of the badla system.

For investors the biggest learning must be to better control the two emotions that are at the root of all market movements, viz greed and fear. Too much of the former was in evidence on Jan 10 when there was no stopping the charging bull, too much of the latter was in evidence when there was no escaping the marauding bear.

The BSE-Sensex lost 119 points last week to close at 18242. The biggest contributors were HDFC (67 points) and Infosys (33) whilst the biggest losers were ICICI Bank (67) and SBI (61), probably in disappointment at the RBI Governor not being reddy, err, ready, to lower interest rates.

It looks as if there would be a sideways movement of the Sensex in a 3000 point band until the course of global events takes further shape. A further rally may be taken as an opportunity to become a little lighter.

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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