The last time there was a bear hug, the markets took five years to recover
by Manas Chakravarty/ BWI
by Manas Chakravarty/ BWI
The bottom has dropped out of the market. At the time of writing, Asian stocks were at their lowest this year and US stocks at their lowest in four months. And the Sensex has fallen over 25 per cent from its peak less than a month ago.
On 6 June, with the Sensex around 10000, bear guru Marc Faber said: “Some asset markets like the Indian, the Russian and the Latin American stockmarkets, copper and other industrial commodities are so overextended that further 30 per cent declines would not surprise me. Therefore, my advice is to sell rallies in stocks and commodities and take a holiday until next October. This would particularly apply for the Indian stockmarket.” Japanese broker Nomura, basing its case on the fact that the Indian market is overleveraged, has said that the Sensex would fall to 7000.
There’s no doubt that local brokers had been giving clients long credit lines. With the market in the dumps, clients are having a tough time paying up. The same goes for other leveraged players like hedge funds, many of which will go out of business, adding to the lack of liquidity. As happens during such crises, the small-caps and mid-caps have been the worst hit. Since these scrips are illiquid, investors are selling off frontline stocks to meet their commitments. To make matters worse, some of the mutual fund new issues had got big corporate money, and they are now facing redemption. In fact, at the time of writing, FIIs had been buying in the cash market for three days while the MFs were selling.
Worse, on a relative basis, the Sensex is still overvalued. Fundsupermart.com numbers show Sensex earnings in 2007 would be about Rs 680. That means the 2007 PE when the Sensex is at 9500 is 13.9, still at a big premium to the Emerging Markets PE (around 11.3). Apart from Japan, India is the most expensive market in the region. So, it could still have some way to fall.
The key question is: how long will it take to recover? A parallel can be drawn with 1994-96. During that time, US Fed Funds rate went from a low of 2.96 per cent in December 1993 to a high of 6.05 per cent in April 1995. Emerging markets worldwide were rocked. The Sensex hit a high of 4334 in June 1994, fell to around 3300 by May 1995. By January 1996, it was at 3100. Then came the Asian crisis. The Sensex finally regained the 4300 level in July 1999, with the tech boom. The climb back took five years.
The good news was that FII flows remained positive in 1994-95, and were negative for only a short period after the Asian meltdown. For emerging markets as a whole, despite the outflows that occurred at a few points during March 1994-February 1996, shareholders continued to invest substantial money. The cumulative net inflow during this period was $8.3 billion, or 44 per cent of assets at the beginning of the period.
This time, there’s no Asian crisis on the horizon yet (the way markets are going, anything could happen, especially if leveraged hedge funds and derivatives start unwinding) and the fundamentals of the Indian economy are stronger. But until some sanity returns to global markets, fundamentals just won’t matter.