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In uncharted waters

After the severe battering the stock prices received over the past one week, the rally on Wednesday was a great relief. The Sensex and the Nifty recovered by 931 and 304 points respectively over Tuesday’s closing levels. The gains are by any yardstick impressive. Yet given the sharp drop in market valuations and the speed at which it occurred, it would be too early to think that a full-fledged, sustainable recovery is under way. By Tuesday evening, the Sensex had cum ulatively lost 4,450 points, more than a 21 per cent fall from the intra-day peak of 21,206 reached on January 10, just 11 sessions earlier. Forecasting stock prices has become hazardous because global factors rather than purely domestic ones are influencing markets everywhere. That is why even the recognition that there is no change in either domestic economic fundamentals or in the expected high level of corporate earnings did little to stem the slide, triggered almost entirely by news of the worsening economic situation in the United States. In India too, there have been a few glaring weaknesses. Stocks such as those in power, real estate, and financial services were riding a bubble and a correction was perhaps overdue. Even before their recent peaks, the Sensex and the Nifty represented valuations far higher than in other emerging markets.

At the start of the new year, the threat of recession loomed large in the U.S., even as the sub-prime crisis continued unabated with serious consequences for the rest of the world. There has also been the larger problem of global imbalances whose orderly unwinding required coordinated actions by central banks around the world. In fact, among policy makers including those in India, there was a sense of unease over the future direction of the financial markets. However, the sharp fall in stock prices in India and the rest of Asia so soon into the new year took everyone by surprise. On Tuesday the U.S. Federal Reserve, which along with other central banks of the developed world, has been shoring up liquidity for quite a while, took the unprecedented step of lowering the federal funds rate by 0.75 percentage point. More than the calming words from, among others, the Finance Minister and the large buying orders from a few public sector institutions led by the Life Insurance Corporation, it was this initiative that stemmed what appeared to be a free fall. It is still unclear if the worst is over. Over the near-term, whether a full blown recession in the U.S. can be averted by the Fed’s latest move and the tax cut package being planned to stimulate the economy will determine market sentiment everywhere.

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