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Markets await a reversal of trends

— FILE PHOTO: AFP

ON A ROLLER COASTER: A ticker on the façade of the Bombay Stock Exchange shows India’s benchmark 30-share index Sensex.

In a week of roller coaster trading, the Sensex was down by 350 points from the previous week. That may be typical of the generally weak sentiment accompanied by volatility. However, share price movements on two days during the week seem to have deeper meanings. On Tuesday, June 1, continuing their recent bearish trends the markets plunged to levels seen last in April 2007.

The Sensex fell below 13000 while the Nifty tested 3900, important support levels. On Wednesday, the markets bounced back. The Sensex gained 700 points and the Nifty nearly 200 points. However, the rally was short lived.

The one day gain on Wednesday was attributed to short-covering. Traders and investors out to make a fast buck in a falling market had sold shares only to buy them back at lower levels. Short-selling and subsequent squaring of positions is an accepted way of making money. They can have a favourable influence on the markets by checking sharp falls, thus ironing out volatility.

The sharp rise in the indices on Wednesday says something about the extent of short-selling that had taken place earlier. Obviously, the bounce back followed large buy orders from traders who had gone short, that is, sold earlier. The other inference is that with Sensex falling below 13000 and the Nifty below 3900, the markets have gone down far enough. From those levels some recovery was more likely than a further decline. That, essentially a short-term view, seems to be an appropriate explanation of what happened during the middle of last week.

The other development behind the rally on Wednesday was the announcement by real estate giant DLF of a share buy-back. Real estate stocks were strong performers on Wednesday but by Thursday whatever cheer the announcement had generated had dissipated. Real estate stocks led the big rally. Many felt that the real estate sector with its market valuations suggested a bubble that was waiting to burst.

Whether that has happened or not or whether the real estate sector actually deserved those valuations is immaterial at this point. What matters is that both on the stock markets’ upside and their more recent downside, the real estate sector along with a few other sectors were in the forefront. The bigger question the answer to which will be of interest to a wider audience is this: have the Indian stock markets reached their lowest point from where a sustained rally can be expected?

Can investors be advised to reenter the markets in the belief that there is at last a reversal of trends? When the indices went below some important marks such as 13000 (for Sensex) and 3900 (for Nifty), many believed that the floors in the current downtrend had been reached. After all, the markets have corrected sharply since January when the Sensex came close to 21000. The nearly 7000-point fall would suggest that the lowest points have been reached. However, consider the following.

One, the extraordinary bull-run took the Sensex to nearly 21000. There was always scepticism as to whether the markets deserved to be there. At the peak, stocks were valued at almost 21 times one year forward earnings. Today, the valuations are around 13 times. Maybe the ‘correct’ valuations are somewhere in between.

Two, macro-economic factors obviously guide the stock markets. Here again, the markets might have exaggerated the country’s macro-economic strengths earlier just as they are downplaying them now. Hard facts suggest that there has been a deterioration over the past quarter or so but there has been nothing so serious as to cause so much pessimism. Economic growth, for instance, is still projected at around 7.5-8 per cent, one of the highest rates in the world.

Three, it is true that in certain critical parameters the economy has slipped. The government seems to have said good-bye to fiscal rectitude. The extensive recourse to the off budget route to subsidise oil marketing companies, fertilizer companies and others is proof of this. The government has not only gone slow on reform but, as the massive bank loan waiver shows, has done a U-turn. The current account deficit is causing concern.

But the question remains whether the market react with such intensity.

Moreover, some of the government’s questionable tactics to window dress public finance were in evidence even last year.

The stock markets not only lived with them but actually forged ahead, at least until January 2008.

Four, of course, oil has made a big difference. Global oil prices have more than doubled over the past year. The impact on India has been severe.

The escalating oil and other commodity prices have stoked inflation in the developed world too. Many emerging economies have inflation rates higher than India’s.

With no early prospect of oil prices coming down, the focus has been on the measures that governments, including India, will adopt to check inflation and its deleterious consequences. The markets’ discomfiture might have more to do with the means the government is adopting.

Five, the looming elections is naturally a factor that is depressing sentiment. The government’s inability to take tough decisions in crucial economic areas is a direct consequence.

Six, corporate earnings that provided the main stimulus to the record bull-run may be adversely affected by the deteriorating fundamentals, definitely over the medium-term and quite likely even over the near-term.

Hence it is too early to predict that the stock markets have found the floor and will gradually begin their climb. Incidentally, the markets’ fall from their peaks in January was not always one way. There were several days when the indices bounced back. Only, the rallies then, as on Wednesday, were short-lived.

C. R. L. NARASIMHAN

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