Silly Musings - Markets

Bloodbath

Pretty late to write on the recent blood bath, but alas, I was too distraught to do anything. (Though of late this is the norm for me). Halal Street (mindfully misspelled) was witness to nothing less than carnage. To put things in more perspective, as is with every stock market event, let me point out where the current correction stands in historical sense.

The biggest Sensex intra day falls have been,

Black Monday

Many of these crashes take place on Mondays leading to the famous or rather infamous ‘Black Mondays’. The only way this can be explained is a trader’s rather unexciting weekend. Either he gets too bored that he starts worrying about trivial things or rather is made to worry after shopping with his wife. So in this panicky mood, the only thing he does the Monday is SELL, SELL and SELL.

In spite of blatant claims by the media of Sensex witnessing its biggest fall, any one familiar to percentages (assuming you do, as you have got this far), the recent fall is only the third biggest. The major reasons for this fall include (Utterly debatable, anyone and everyone can disagree with me),

Global cues

Should I say more? The subprime crisis has snowballed into a major crisis drying up funds in the US and over Europe which has directly affected their markets. Due to the crisis, the FIIs (Foreign Institutional Investors) have had to unwind their position in India. Now allow a little detour as to understand how the FIIs have made huge profits in India.

India touted as the best emerging market is growing at about 10% YoY basis. Add to this, the global interest in India had made most FIIs flock to India. This means there was a large supply of dollars and Rupee was being bought to invest in India. That explains theappreciating rupee. Now let us assume for simplicity that the FIIs have earned a return of 10% on their investments in rupee terms. Now with a weak dollar, it makes much more sense for them to book their profits and get out of here as in Dollar terms, the returns will be even higher than 10%.

OK. I will make it simpler. Say I brought in 1000$ at 45Rs/$ a year ago. So that means I invested 45000 Rs. Now this year it has grown to 49500Rs (10% growth). But in dollars I would have earned 1237.5$ (assuming 40Rs/$) which means about 23% return on investment. Now that is a double whammy. So makes more sense for the FIIs to book their profits and get out of here.

Margins

This could get a little complicated. When dealing with derivatives, (Contracts that derive their value from basic stocks), traders are required to submit margin amounts. The margin amounts usually vary between 10% to 20%. This provides the much hyped ‘leverage’. To better understand it, consider this.

There is a stock quoting at 100 Rs. Now in a future contract, you need to pay only 10 Rs for it. Now if the stock trades and ends the day at 110Rs, your contract is worth 20Rs which means 100% return on investment, whereas the stock has only appreciated 10%. Same is the downside, a 10% fall means your capital is wiped out. This is leverage. You buy more with

less money. (I have conveniently ignored factors that determine the future contract price which may not be the same as the stock price at the end of the day, in my quest to keep it simple.)

The recent bull-run had reached such enormous proportions that, even that 10 to 20% to be given as margin was quite a considerable amount. And brokerage houses tended to accept shares from its clients in place of money for the margins needed to be provided.

But as is with future contracts, at the end of day, the contract is marked to market, meaning you have to provide money in case you have made a considerable loss. But the people who had provided their shares as margin either went bust or could not get cash quick enough to replenish their accounts (inefficient banking systems). So as a result of the loss they had suffered that day, the stocks they had provided were sold by their brokers in order to recover the cash needed to clear their positions. This kind of relentless selling drove the markets down to abyss.

Reliance power IPO

Many might not agree, but still I would have it right up there as one of the reasons.The issue at a size of 11, 700 crore at upper cut-off price got over subscribed 69 times. Hence it sucked a lot of liquidity out of the system. Blatantly using one of my Professor’s line, ”Ambanis are son-in-laws of the government, they can get away with anything”, will justify the kind of euphoria associated with the issue.

Now I will try to justify how bad an issue, Reliance Power is. A company that does not have anything on its balance sheet, no running plant and with just projected earnings, Reliance Power has been more than successful in raising capital. If it lists at 900Rs per share, it gives it a market cap of Rs 2 lakh crores, which was the market cap of Reliance Industries (Established company) a few months ago. In 4 years they plan to have 28000MW running capacity. Whereas a stock like NTPC which already has 28000MW installed capacity and has expansion plans has a market cap of less than Rs 2 lakh crores (with equal debt levels as Reliance Power). Also NTPC has the highest capacity utilization in the sector at about 90%.

Investing is not entirely a mind determined action, though ideally by capitalistic definitions it should be. Men think more with their heart than mind when it comes to women, war and money (Yours truly is no different. Have applied for 900 shares). When as much as 8 lakh crores is blocked for the IPO, it needs more than a miracle to expect people to hold on, booking their losses in the future position in the current fall. So the issue is one of the main triggers for the fall, more so because of the bad omen it portended in its last day.

Lighter moments of the Fall -The trade halting goof-up

Long term effects

The markets may come back to their original levels in a week, a month, a year or at the most a decade (During the Harshad Mehta scam, Sensex fell from 4000 and took 7 years to reach it again). But the traders who had future contracts and other derivative instruments have suffered irreversible losses, as they are now out of money to participate in the recovery. Many of them will never return to the stock markets and will look for making a living somewhere else. And going forward the RBI will at least in steps increase restrictions on FIIs curbing this kind of pullout from the markets. This will be beneficial to the markets in the long run. What is needed is more domestic participation than FIIs prowling for profits.

Also for bargain hunters, they cannot have a better chance to buy stocks that were available at discounts as all sectors got rerated. If you are planning to build yourself a portfolio, then there cannot be a better time to pick up some quality stocks ([email protected] for recommends).

Significance of equity and other financial markets

Stocks tumbling all around the globe on the wake of the sub-prime issues in the US, gives non believers in stocks enough mileage to further their self fulling prophecy of wisely staying out of it. But can anyone really be totally unaffected by stock markets. In capitalist and mixed economies atleast, it is not possible.
Even if you are not invested in the markets, you, your spouse or your parents are working in a company that is listed in the market and hence their compensation is invariably tied with the performance of that company's stock, which in turn is tied with the general health of the country's stock market and the global market trends. Indirectly all the products and services you make use of, is provided by corporate entities. So a stock market bubble burst may close down these companies or drive their product/service prices northwards. My roomie Suresh, still was not convinced with this line of argument. He questioned how come a beggar on the road is affected by the markets. But is it not obvious? Ultimately it is a person employed with a listed company or a stock trader who drops coins to the beggar.
So who can be the real ones who are totally unaffected by stock markets. There are two possibilities. One is a perfect socialist state. Also this socialist state should remain a closed economy, meaning not trade with other countries of the world. Such a closed socialist country where the state owns all means of production and is the only employer can remain unaffected by the stock markets. But such idealism cannot be applied to our world.
The other are the tribal groups that are totally secluded and have no means of communication with the rest of the world. There are only few groups that are present like that in today's world. The kalahari bushmen from Africa and few trial groups in the Andaman like the Sentinelese, Negrito and the great andamanese.

Volatility

A euphemism for people losing hard earned money in the stock market. As I am writing this article the BSE and NSE are tumbling down from dizzying heights. It is the time investors feel that they should have booked their profits earlier and come out of the stock market. Others like me tell themselves that it is all like a wave and we are just experiencing a trough. So what made me write this article?? Probably the thousands I lost.
The fall has been attributed to a number of reasons. One of them being the fear about rising inflation rates in the US. Indian inflation rate has hovered around 5% for some time. The US rate which was much lesser before is also feared to approach the Indian rate panicking investors all around the world.
The fall has also been attributed to slow global economic progress. Although countries like India and China have impressive GDPs of about 8% and 10% respectively, the global GDP has been an abysmal 4.5%. Also the developing countries stock markets have shown a general decline in the past week with the Indian market falling steeply.
As happens with any global phenomenon, it is natural to place the blame on global oil prices. The economics behind world oil prices is interesting. The OPEC (Organization of the Petroleum Exporting Countries) controls about 67% of the world oil reserves and hence dictates world oil prices. Whenever it wants to raise prices, it just reduces production. Also the producers never try to reduce the prices as it directly encourages consumption which in turn leads to global warming. Now Venezuela is coming forward as a major source of oil due to high oil prices. The quality of oil in Venezuela is low grade and costs a lot to be made usable. But the high prices now make it possible allowing Venezuela to produce oil. Also one interesting fact is that in India from the time I have started driving two wheelers a litre of petrol cost 20Rs then in 1990’s and now it is around Rs50 in 2006. But amazingly the US gas price has been ranging from $1.91 to $2.68 per gallon(3.8 litres) for the past fifty years. The lowest oil price is in Venezuela costing about 0.12$ per gallon. The US with its gas guzzling SUV’s is the largest consumer of world oil but has done little to reduce dependence on oil. Instead it has only tried to secure its supply by constructing Strategic Petroleum Reserves which are nothing but underground salt caverns which can hold large amount of oil. Their reserves can help them hold out for sixty days in case of any crisis.

SPR at Bryan Mound Texas

The initial stock market fall can also be attributed to the left grasping power in West Bengal and Kerala, thus causing the foreign investors to worry and pull out ( fall of 500 points in a day in sensex) which further created a domino effect including the mutual funds to pull out(A fall of eight hundred points in the sensex). Last comes the retail investor who pulled out in order to reduce his losses. But still I stay invested. Why???? I think it must be because I often show high risk behavior in the market and I believe that any one’s risk appetite is inversely proportional to their age.
For anyone wishing to become part of Dalal street, I think that this is the best time to enter. As even all blue chips are priced at a discount, it is a good time for investors to enter the market. But alas I have no more cash to pump in. (My bank balance now is about 1000 against a minimum balance of 5000).
The Indian growth story will continue and I firmly believe that inspite of these corrections, the sensex will surge ahead and outperform expectations. So my kind advice would be to stay invested and to increase your portfolios.
For those interested to enter the market now,my recommends would be
1. Infosys technologies
2. Reliance capital
3. ITC
4. Pantaloon retail
5. ONGC