Black Monday

Today is Friday. But twenty years back it was Monday, October 19, 1987. The day when the Dow Jones Industrial Average (DJIA) witnessed a fall of 508 points or 22.6% - biggest percentage drop ever on a single day in Wall Street. It almost resembled the crash occurred on October 28, 1929, which set in Great Depression. The month of October is notoriously famous for crashes in stock indices.

The difference between these two crashes is that fortunately in 1987, the fall was arrested in the next few days though it took almost two years to regain its glory. There was no significant fallout on the long term investors.

The significance of the crash of 1929 lies in the fact it lead to economic depression followed by shifting of economic and financial power from Europe to the United Sates of America.

Similarly, in 1987, the crash had lead to transfer of economic power to Japan from the US. Reasons are not far to seek. Japan was producing more than its consumption, whereas US was consuming more than its production. Japan was amassing assets abroad whereas US was incurring debts on its assets. The US dollar was depreciating, albeit slowly. Japan assumed the role of banker, accepting deposits at lower rates, and lending at higher rates.

US companies were happy to borrow; indulged in leveraged buyouts, believing that companies would grow exponentially simply by constantly purchasing other companies. Investors were caught in a euphoria. The euphoria made people believe that market would always go up. When the crash took place, within one day $500 billion worth of wealth was evaporated from the Dow Jone index. Some individual investors started shooting their brokers and some committed suicide. The majority of the investors, who were selling, did not even know why they were selling. Everyone was selling so they sold their holdings. Of course, when they purchased these stocks, they did not know why they were doing it, except that everyone else was buying.

Half of the thirty stocks which constituted DJIA in 1987 are not only still retaining their place in the index but have enhanced the wealth of investors substantially. Procter & Gamble is approximately up by 1800% since October 19, 1987 with least returns coming from General Motors, which is up just by 82% (excluding dividends). Rest of the companies took leave from the markets on account their merger with other companies. Some had been replaced by new entrants like Microsoft, Intel, Walt Disney etc. This data clearly shows that long term investors have been fairly rewarded.

What happened in the last two days in the Indian stock markets is quite similar to the crashes described above. However, similarity begins and ends there. Here is a stock market trying to catch up with the economy, which is at ‘take off’ stage, with lot of potential for sustained economic growth in the coming years. How many working democratic countries are there today, that are growing at above 9% growth rates, inflation at decade low, strong currency, robust financial markets, growing tribe of entrepreneurs coupled with the need for building infrastructure requiring approximately $600 billion? Most of these figures are arrived at without taking into account the contribution from the unorganized sector, both in manufacture and services.

The fall in the stock markets occurred following the release of a draft paper by SEBI to make registration mandatory for foreign investors (mostly hedge funds), who are so far taking the easy way in the form of Participatory Notes. The effort by the SEBI is understandably a step in right direction. What is sought now is mere registration. SEBI being the securities market watchdog is entitled to know the credentials of market participants. ‘Know your participant’ is very much essential for the regulator to discharge its statutory function of regulation of securities market and protection of investors. Of late, large amount of foreign money is entering India in the form of P Notes. However, FIIs who are creating sub-accounts to issue these P Notes, do not have any details about their foreign clients. Two years back, when SEBI asked UBS for details of its clients, it was not able to furnish. It was then barred from investing in India. Section 20 of SEBI’s FII rules clearly says every FII shall, as and when required by SEBI or RBI, submit as the case may be, any information, record or documents in relation to its activities as required by the regulators.

For the orderly conduct of stock markets, safeguards must be put in place. The timing and quantum of safeguards are always open for debate. There is always scope for improvement of the system. Any number of suggestions can be made in this regard. Foreign portfolio investments are always welcome but not the kind of money, whose colour could not even be investigated by the regulator. What is welcome is white money. Neither black money nor terror money. In the short term, there may be fluctuations both in capital markets and forex markets. But SEBI’s latest initiative will go a long way in ensuring stability in the bourses.

Mr Market

What a ride? It is time of records in the history of Indian stock markets. Records are being rewritten on a regular basis. Almost a journey of 1,000 points from the day’s low on Tuesday last. Mind-boggling feat indeed on a single day. In the process, it not only crossed 18K but appeared invincible to cross 19K too. For the last couple of days, the so-called pundits from the business channels have been shouting from the rooftops that markets might take a U turn going forward. Mr. Market gave no cognizance to their opinions.

Why this is happening? Is it possible to predict the movement of broad market indices simply on the basis of technical analysis or with aid of probability techniques or for that matter with that of quantitative methods.

No doubt, stock markets in the emerging markets like India have attained such a criticality that it is becoming increasingly difficult to guess the movements unless you are clairvoyant.

The resurgence started with the Ben Bernanke’s Feb Reserve rate cut intended to avert subprime housing crisis in US. After that stock markets in the emerging markets stopped looking back. Funds flow continues. As if the phenomenon of globalization suddenly dawned, capital started to find new areas relentlessly. With the gradual integration of financial markets across the globe, financial capital moved around internationally. Being the the essential ingredient of production, it will seek to go where it is best rewarded. India is now able to do precisely that. But the speed at which it is changing priorities is beyond comprehension of experts.

Besides, there is one more factor that might be adding to the dollar flows. The recent surge in crude oil prices made several entities in the west Asia flush with fresh profits. Earlier, money used to be parked in safe and secured economies. This oil money is now routed to high rewarding emerging markets, thereby creating a bubble like scenario.

Front line stocks led by Reliance are the first beneficiaries. Their appreciation in prices fueled Sensex and Nifty to record new highs. I feel in the next round, second rung stocks will go up, though bellwether index may remain more or less at the current level. This is apparent taking into consideration the prices of blue chip stocks reaching their life time highs almost vertically; going forward, upside potential seems difficult unless major surprises surface.

Given the rosy economic fundamentals, Mr. Market will love to play the role of Santa during the current festive season. Notwithstanding our views on the market, it will continue to teach us how to value businesses in the changing scenario and think about market prices.