Sensex, Nifty crash on sixth consecutive day; here are old new investment lessons from ongoing carnage at markets
FirstPost
Feb
06, 2018
It
took the BSE Sensex, India’s premier stock market index, nine months to rise
from 30,000 mark to higher than 36,000 level. This meant a return of more than
20 percent from April 2017 to January 2018. In an era when fixed deposits give
a post-tax return of 5 percent per year, a return of 20 percent in less than a
year has to be fantastic. Of course, there are many listed stocks which have
given more than 20 percent returns in during the same period.
Between
29 January and 6 February, 2018, the BSE Sensex fell by around 5.8 percent and
wiped out one-third of the gains in the nine months mentioned earlier. his
means a week’s fall has wiped off one-third of the gains over a period of nine
months. When the stock market falls, a new set of investors learn, the same set
of lessons all over again. What does this mean?
The
price to earnings ratio of the BSE Sensex crossed 26 in late January 2018. This
basically means an investor was willing to pay Rs 26 for every one rupee of
earning for the stocks that make up the Sensex. In the nine months, the price
to earnings ratio of the Sensex had moved up from 22.6 to 26.4. This means
while the price of the stocks kept rising, the profit of the companies they
represent did not move at the same pace. At the end of the day, the price of a
stock is a reflection of the profit that a company is expected to make.
The
price to earnings ratio of NSE Nifty touched 27 in late January 2018. The
midcap stocks were going at a price to earnings ratio of 50. And the small caps
had touched a price to earnings ratio of 120. Such price to earnings ratios, or
what the stock market likes to call valuation, were last seen in the years 2000
and 2008. With the benefit of hindsight, we now know at both these points of
time, the stock market was in a bubbly territory.
In
fact, all the occasions when the price to earnings ratio was greater than in
the recent past were either between January and March 2000 when the dotcom
bubble and the Ketan Parekh scam were at their peak, or between December 2007
and January 2008, when the stock market peaked, or before the financial crisis;
which finally led to many Wall Street financial institutions going more or less
bust, broke out.
Nevertheless,
the stock market experts told us that this time is different because there was
no bubble in the United States of the kind we saw in 2000 or that the financial
crisis that broke out in 2008, was a thing of the past. Hence, there was no
real reason for the stock market to fall. (Of course, to these experts, the
lack of earnings growth did not matter).
The
trouble is that when the markets are in bubbly territory, there typically is no
reason for them to fall, until some reason comes along. The first reason came
in the form of the finance minister Arun Jaitley, introducing a long-term
capital gains tax of 10 percent on stocks and equity mutual funds. This tax
will have to be paid on capital gains of more than Rs 1 lakh, starting from 1
April, 2018.
Investors
took some time to digest this, and the stock market fell by 2.3 percent, a day
after the budget. If this wasn’t enough, the yield on the 10-year treasury bond
of the American government came back into the focus. This yield jumped by
around 40 basis points to 2.85 percent, in a month’s time. This yield sets the
benchmark interest rates for a lot of other borrowing that takes place. In the
aftermath of the financial crisis that broke out in September 2008, the central
banks of the Western world, led by the Federal Reserve of the United States,
printed a lot of money to drive down interest rates.
This
was done in the hope of people borrowing and spending money and the economies
recovering. That did not happen to the extent it was expected. What happened
instead was that large financial institutions borrowed money at low rates and
invested them in stock markets all across the world. This phenomenon came to be
known as the dollar carry trade. All this money flowing in drove up stock
prices. The problem is that as the 10-year treasury bond yield approaches 3
percent, dollar carry trade will become unviable in many cases. Given this,
many carry trade investors are now selling out of stock markets, including that
of India.
The
larger point here is that nobody exactly knows when the stock market will
reverse. The way the market has behaved over the last few days, has proved that
all over again. The sellers are not selling out because the valuations are too
high (they were too high even a month or two back). They are selling out
because of an entirely different reason all together; investors are selling out
because they are seeing other investors selling out. The herd mentality that
guides investors to buy stocks when everyone else is, also forces them to sell
when everyone else is.
Also,
the stock market, when it falls can fall very quickly. The last generation of
stock market investors learnt this when the BSE Sensex fell by close to 60
peercent between 9 January, 2008 and 27 October, 2008. Is it time for this
generation of stock market investors to learn the same lesson all over again?
On that your guess is as good as mine.
Comments
Post a Comment