Now that much of the dust has settled, one can take a dispassionate view of the situation and evaluate the reasons and the opportunities thrown up. Since Black Monday on May 15, 2006, the markets saw a virtually continuous fall with some smart recovery.
The fall has not only affected stock markets but was felt globally on all classes, virtually without exception. One significant highlight in India has been that many mid-caps and small-caps have hit 52-week lows -- which shows that the year-long run-up had spread to undeserving stocks too.
Is this a correction or will the effects last? Let's address these issues.
Were the analysts wrong?
This is one grouse heard frequently. The fact is that virtually every decent analyst got it right -- it's just that investors had developed selective hearing due to the long Bull Run!
The issue was never 'whether' but 'when' and everyone from Citigroup to Morgan Stanley to Merrill Lynch to Indian brokers had predicted the fall fairly accurately.
Of course, in markets with single side movement, it is often impossible to put a reasonable time frame on the reversal: to paraphrase John Maynard Keynes, 'Markets can stay irrational for far longer than you can stay solvent!'
There were two main reasons:
- The regular increase in US Fed rates made an attractive risk-free return.
- Over-leveraging in our markets made the fall steeper.
The last few years had seen a surfeit of liquidity globally which would eventually lead to inflation and the only way to combat this is to raise interest rates -- and that is precisely what happened across the world as country after country increased interest rates.
Locally, when interest rates rise there are two major effects:
First, money moves from equity markets to bond markets and, second, borrowing cost for industry goes up effectively lowering their net profits.
As a thumb-rule, a 1% interest rate rise equals a 10% fall in equity markets. The entire (global) situation led to an emerging markets sell-off which was triggered by the metal meltdown which in turn was a victim of rampant speculation.
Secondary factors like mutual fund redemptions and squaring-up of futures positions accentuated the fall.
To reduce the pain, authorities can take work towards stopping the volatility. This would be the first step in bringing confidence back to the markets. I doubt that any investor -- in India or abroad -- wants to invest in a market which moves 3-5% every day!
Secondly, stock-lending -- the better half of margin trading -- must be in place and plans are already afoot to kick-start it; and finally starting the much awaited RTGS (Real Time Gross Settlement) across a wide cross-section is a must-do.
The current banking system typically takes three days for a cheque to clear though margin payments in equity markets have to be made daily -- a clear mismatch which led to frantic squaring up, volatility and backwardation (futures prices being lower than spot prices).
This is the bottom!
Every boom and bust throws up situations, which can be profitably cashed in. The recent fall, irrational in its secularity, had promoters queuing up to buy their own stocks through creeping acquisitions. One significant example has been that of Swiss cement major Holcim buying over 2% in ACC via Ambuja Cement in the first 15 days of June when the fall was sharpest.
Promoter buying indicates inherent value -- who can value the stock better than the promoter? Maharashtra Seamless, Orchid Chemicals, GE Shipping, Glenmark Pharma and several others are among those in which group companies or directors have bought shares from the open market during the fall.
Incidentally, the same thing happened in 2003 when prices were depressed and MNCs started buying back their own shares to consolidate their holdings at low prices.
Moreover, value buying has emerged in most large-cap stocks expected to benefit directly from the growth in GDP.
Opportunities and changes
For retail investors
Every boom and subsequent bust sees retail investors at the rough end of the business. The trick is to keep a few simple things in mind before investing. Individual stocks, after steep falls, are transitorily available at very attractive prices since markets do get temporarily irrational and tend to go into excess territory on rapid rise and falls.
These swings should be used to spot opportunities to buy/sell. Some stocks become attractive dividend plays (Bank of Maharashtra which was giving a tax-free return of over 7% recently and several other opportunities like Sirpur Paper, etc.).
Another great way to invest is via Systematic Investment Plans because it is virtually impossible to time the markets as explained earlier. Retail investors should be cautious to avoid Futures and, if they wish to leverage, can start using Options, which is a great product to mitigate risk.
And most importantly, investors should be ready to change their mind when situations change and not get obstinate about the stocks they are invested in.
For brokers
Surely, financial services businesses will see accelerated mergers and acquisitions as small brokers get crowded out and only those with financial muscle and a nationwide footprint will survive.
Once the M&A is done, brokerage rates will rise -- but the good news is that they will fall before they rise, as large newer entrants will use price as a competitive tool to enter the markets.
This fall will also force brokers to educate their clients on relatively more sophisticated products like Call and Put Options as well as arbitrage-based investment solutions.
For corporates
The share prices fall represents an opportunity for promoters (and others) to consolidate holdings at low cost. However, with interest rates slated to go up further, expect bottomlines to be hit and earnings forecasts to be toned down. This is the price we pay to contain the inflation devil.
Secondly, the IPO story has more or less ended for now and that marks the temporary end of one of the cheap sources of funds for industry.
The future
Lessons from other crashes internationally indicate that typically it takes several months to come out of steep falls like this one. However, we are still in a bull-run technically since the index has fallen back only five months though the run-up is more than a year old.
Moreover, our GDP growth is still 8+% and makes us an attractive destination for investors worldwide. Whether the fall can be termed as a correction or a trend-reversal will only be clear later.
The lesson for investors: All equity market investment is at first positive anticipation of the company and the sector but is ultimately a call on the country's economy and therefore long-term. In our globalised markets, equity investments depend on several extraneous factors beyond our control.
But, rather than fruitless inaction or regret, the temporarily irrational movements of markets can and should be used to further our investment objectives.
The author is senior vice president, RR Equity Brokers.
