Saying “I told you so” has a curiously unsatisfying quality to it. That the market was crazily overvalued was apparent to most, but when the Sensex was rising so much , it was hard not to lose one’s conviction. However, even during the Sensex’s upward march, a sequence of events was beginning to come together which has finally resulted in the sudden market correction (notwithstanding yesterday’s sharp upward swing). I have described these factors in my previous columns but will recap.
First, while there is a sound basis to the India story and Indian economic fundamentals are strong, resulting in three years of plus 8% growth, in reality the market has just as much been driven by global liquidity. For many years, real interest rates in the US have been benign, notwithstanding the recent increases in the Fed Funds rate. Global central banks have been pumping liquidity into their respective economies to revive economic growth, particularly in the Eurozone and in Japan. This liquidity, in its search for returns, eventually began to find its way from the mature into the emerging markets. Within the emerging ones, India emerged as a large growth market with great entry valuations. Unfortunately, the most active players in this flow of liquidity have been hedge fund investors.
Second, it takes time for macro imbalances to begin to manifest themselves. But once an indefinable point is crossed, the reversal is usually sharp and swift. It’s like a binary situation—the markets tend to go either one way or completely the other. Examples are the Mexican peso crisis, the Russian and Brazilian devaluations, the Asian crisis, etc.
The reason for this is that global fund managers, for all their analyses, fundamentally tend to act together. There is safety in numbers. This is because while hedge funds are absolute return investors, they do compete with each other for the same dollar. So they need to keep an eye on each others’ activities and benchmark themselves against each other.
Three, global imbalances such as higher oil prices, low real rates in the US and strong consumer spend there on the back of refinanced mortgages, and its eventual fading, had to make their presence felt sooner or later.
• India has emerged as a large growth market with good entry valuations
• Sadly, most of the active players in the liquidity flow were hedge funds
• Leading to a situation where the market went up too much and too fast
India has, so far, shown all the classic signs of an emerging market caught up in, and driven by, external circumstances. The market went up too much and too fast, as investors poured into the country. When exactly the tipping point was reached in the international capital markets from a benign sentiment of low inflation, low interest rates, high liquidity, high growth environment, to an inflation-worried, rising interest rates, low liquidity and slowing global economic environment—is hard to say even in hindsight. Forecasting the tipping point is, therefore, well nigh impossible. But it does appear that an important point has been crossed and the global economy is going to face a more difficult environment going forward.
What is the likely impact on India and Indian corporates? For one, the domestic economy continues to remain strong. Industrial growth is still good, the Indian consumer should not be significantly affected by the stock market correction. There might be some correction in what some might argue is an overheated real estate market, but that should simply propel further demand.
Corporates plan on the basis of long-term factors and therefore we should not see any significant changes in their announced expansion plans. Overseas acquisitions, which a number of Indian corporates are examining, should actually become a tad easier as company valuations decline. To the extent that some corporates have plans to access the stock markets, this would have to be done at more realistic levels. Rising interest rates may have a more lasting negative impact on both Indian consumers and corporates, as it makes borrowing more expensive while at the same time increasing the cost of capital in allocation decisions.
Having said all this, I am still optimistic about Indian fundamentals. Were the market to be driven purely by domestic factors, it would likely not have increased and then corrected so much, but would still likely have been at similar levels. It is just that we have seen a much higher level and a 25% correction that we are getting worried. By itself it is still a significant increase from where we were at the same time last year.
Source: The Financial Express