The Hindu Business Line : Down is up for global equity markets

Movement like a pendulum from over-exuberance to over-pessimism always creates great investment opportunities, just as in the present stock market scene.

Sunil Kewalramani

It is feared that the rebound in the world equity markets is only temporary and that the US is already in recession or this is, at best, a bear market rally. Most journalists and business commentators do not think the five-year old bull market will continue. They are either non-committal or believe that every rise is going to be accompanied by liquidation, in effect, taking us nowhere. The very fact that sentiment is so downbeat itself means that it is bullish for the worl d stock markets!

Even with the most negative news hitting Wall Street on February 20, 2008 (rise in sub-prime defaults even before resets, oil crossing the important milestone of $100, rise in the US Consumer Price Index), Dow Jones reversed its earlier fall of 105 points to end the day up by 90 points. This clearly indicates the negative news has been priced in and stocks are now set for a rebound.

In India, the Finance Minister is about to unveil the UPA Government’s last Union Budget on February 29, and it is expected to be extremely market-friendly. It is surprising that most commentators are even wondering whether the Budget should be or will be a non-event, as in preceding years.

In an emerging economy such as India, the Budget should be a means of the Government’s unfurling policy initiatives and motivate the citizens to achieve extraordinary rates of growth.

Various tax and other initiatives are expected to be announced to boost consumption and all this will augur well for the corporate sector. Even reduction in and rationalisation in excise duties on oil and petroleum products is expected, with multiplier effects on the economy.

Fed effect

One must also not forget that in the last US Presidential year, 2008, the Fed will keep cutting interest rates and the US government will keep providing stimuli to keep recession at bay. The dose of interest-rate cutting may keep changing throughout 2008, but the government will make sure the winds of recession stay away. So, the fears of US recession are exaggerated.

Besides, the data-points on the basis of which US recession is being forecast are very erratic and keep changing violently from one period to another. When US retail sales were expected to rise (because of the holiday season) they fell; and when they were expected to fall (because of the cold weather conditions) they rose unexpectedly. Drawing conclusions based on such erratic data-points could be meaningless.

In the US S&P 500’s history, there have been only three negative fourth years of a US President’s term. In 1932, as the Great Depression bottomed; in 1940 as the World War II began to come on force in Europe; and in 2000, after the burst of the tech bubble. The US sub-prime crisis, does not seem to be a case that will add to the fourth negative fourth year of a US President’s term.

Although the world equity markets have moved to price in a recession this year, commodities have actually gained. The S&P GSCI non-energy index, based on commodity futures, is up 11 per cent for the year.

For those who argue this could be because of supply disruptions in China due to severe storms and inclement weather, which have caused severe supply bottlenecks, it must be pointed out that the S&P GSCI non-energy index is up 27 per cent since the US Fed started cutting interest rates in August 2007 (which means it went up 16 per cent during Aug-Dec 2007, even after ignoring the possibility of China weather-induced supply bottlenecks).

Even industrial metals, most sensitive to industrial demand in the emerging world, are up 11 per cent for the year, according to Dow Jones-AIG. Precious metals are up 9.6 per cent for the year, as are agricultural commodities, which continue their upward ascent.

Reliance Power

Concerns have been expressed in several quarters about the Reliance Power IPO and its excessive valuation. While there is no denying that the valuation was on the higher side, it is always possible that the ADAG group can secure projects in areas and geographies never before ventured into or imagined.

The markets always tend to overreact. Especially in the emerging markets, the stock market indices are moving like a pendulum from one extreme to another. In India, on the upside, they gave heavier-than-necessary valuations to power stocks, discounting earnings three to five years forward.

Volatility of stocks that over-react to change in sentiment prevailing at a particular point of time is maximum. For example, in the three-day capitulation period of January 2008, RNRL saw an intra-day volatility of 66 per cent, closely followed by Neyveli Lignite at 62.3 per cent. It is only a matter of time before these stocks return to find their equilibrium.

US decoupling

When experts say we have not really decoupled from the US, they also say that when the sub-prime crisis began, for several months, we were decoupled from the US but later on we recoupled. This is ridiculous. If this was indeed the case (i.e. we were first decoupled, later recoupled), there must be surely some reason to explain this phenomenon, such as the lead-and-lag effect, which remains unexplained by most theorists and practitioners.

We have heard all the same concerns over and over again, every-time we log on to the financial Web sites to check ‘Just-In News’ or ‘Breaking News’ or when we hear Business News on financial channels. Sub-prime crisis, high oil prices, US recession, tumbling dollar, high US deficit, etc. The day’s front page news is all old news, and, in stock market parlance, old news is no news.

According to the Efficient Markets Hypothesis, stock markets efficiently discount all widely known information. Frightening or elation-causing news gets nearly instantly reflected in the prices. The sub-prime mess and the high oil prices have been there for long.

Even the losses of various financial sector institutions and banks are by now old news. There is no earth-shattering news that has suddenly presented itself. Repeating the same old news will in itself not create a bear market, and I seriously doubt we have entered one.

Movement like a pendulum from over-exuberance to over-pessimism always creates great investment opportunities, just as in the present stock market scene. The initial rise in the Indian stock market was in large-cap stocks, followed by the mid-caps and small-caps. Now, the rebound will again be in large-cap stocks as investors try to regain confidence, followed by mid-cap and small-stock stocks. This should continue until euphoria returns and the pendulum swings once again.

In conclusion, the world stock markets I believe will rebound over the next three months to re-test the previous highs.

(The author is a Mumbai India-based Financial Consultant. He advises foreign financial institutions and NRI clients on FDI and Portfolio Investment matters. Disclaimer: It may be safely assumed that I may have advised my clients in accordance with the opinions expressed by me above and that I/my clients would have invested accordingly in stocks.)

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