The Hindu Business Line : Beware the gyrations

WITH THE STOCK market closing out the week on a flat note, thus arresting the fall of Thursday, investors have reason to look ahead with greater optimism. While in absolute terms the Thursday fall was large, in the context of the current levels of valuation, it cannot be considered too steep. In percentage terms, the decline was by no means exceptional and certainly nowhere quite near the drops when the market was caught in a speculative frenzy — for instance, in the wake of the 1992 securities scam or, more recently, in early 2000, when Ketan Parekh hit the market. Thus, there is less reason to fear the existence of any systemic flaw in the present valuation. Of course, there could be a certain amount of mis-pricing or even irrational exuberance in the valuation of select stocks.

It is in the very nature of a market that there should be a certain degree of volatility. After all, when the underlying basis for valuation has to do with the perceptions of a myriad investors about the quantum of benefits likely to accrue from these assets, there is bound to be some swing in the value. In the case of financial assets such as stocks, the problem of volatility acquires an extra edge. They are valuable not so much in themselves as because they represent some tangible piece of income-earning assets. The phenomenon of the stock being one step removed from tangible pieces of property often makes investors prone to vesting them with a value all of their own, often in the misguided belief that someone else would offer a higher price than the one at which they themselves bought it. That `someone' may prove elusive or may not so readily suspend rational judgement, leading to the stocks finding a level more in accord with the income potential of the underlying business asset.

It is in such a milieu that stocks become vulnerable to questionable news reports about governmental probes, police investigation, and so on. In the days before the current detente between India and Pakistan a few extra bullets fired across the LoC would be dramatised as tensions along the border and how the two countries went to war over Kashmir three times in the past with disastrous consequences for valuation in the stock market. That stories of official probes are denied by the official sources a day later or that the tension on the border dissipates as quickly in the media as it was recorded is of little use to someone who has had to close out his position in the market at a considerable loss. Retail investors would, therefore, do well to remember that they are better off going by business fundamentals and staying in for the long term rather than depending on the `greater fool' of an investor to provide them quick profits.

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