Indian Stock Markets Crash - Good Time to Invest

January 22, 2008

I am sure that everyone has been reading about the fall that the Indian stock markets have witnessed in this year, more so in the last two days. The Sensex has lost 17.53% since the beginning of this year and Nifty has lost 20.19%, bulk of it in the last two days. Today, the market was suspended for one hour as the indices hit the lower circuit of 10% on opening. India is the worst performing market this year so far, next only to the Hong Kong Hang Seng that has fallen 21.77% this year. The market fall has been described in many words in papers/websites - freefall, crash, saare zameen par, etc. etc.

Is this a good time to invest?

Firstly, why have the markets fallen so much in 2008? It is due to a combination of factors, the key ones being

  • the negative global sentiment that is prevailing
  • recent IPO of Reliance Power (which had an overwhelming response)
  • selloffs by FIIs
  • aggressive positions built up in the futures market
Once a selloff starts and goes beyond a point, then it begins to have a catastrophic effect on the market. Why? Simply because the aggressive positions built up are leveraged positions. Which means that the positions have been built up by borrowing money. There is a margin put up (usually a % of total value) and this margin needs to be maintained by the investor. And this margin is tracked real time.

Beyond a point, the margins become insufficient and further margin calls are made on the investor (by the broker) and also on the broker by the exchange (the broker has to keep a margin with the exchange). If this margin calls are not met, then the broker simply sells off the stock in the market.

Imagine this situation happening on a large scale and you can very well picturise a scenario where the brokerage houses are on the phone with the investors asking them to top up margins and in the event of margins not in place, selling off stocks. This selling off fuels panic in the markets and that is what has happened in the last two days.

Now why do I say that this is a good time to invest? Consider the following factors:
  • The Indian economy is still fundamentally strong and would grow at 8.0% to 8.5% this year. India and China are the two fastest growing economies in the world
  • The results posted by the companies are in line with expectations of the market. And the figures on tax collected by the government also show a good increase for the quarter which means that the other results that would come out in the next 10 days would also be good
  • Interest rates are at a peak and though RBI would not change the rates now, they may reduce the rates in the second half of this year
  • Mutual funds/insurance companies are now on a buying spree. MFs have recently collected a lot of money through NFOs and they are now in the process of investing these proceeds. Insurance companies, especially LIC, is rumoured to be on a buying spree and they have bought around Rs. 300 crores in the market on 21/Jan alone
  • At current levels, Sensex is trading at 17 times FY09 earnings. This is reasonable as compared with other markets and also is in line with the long term average of 16.5 times earnings. And this is cheap compared to the PE ratio of China which is 45+

So, if you have a medium to long term view (not a trading view), the next few days are great to invest (if you have not done so today)

Note: The Fed rate cut of 75 basis points on Tuesday will provide some short-term juice to the markets, while not addressing root causes or stopping the unwinding currently underway in global markets. [Ed.]

Disclaimer: This article does not recommend any investment decisions. Readers are strongly urged to do independent research and make their own conclusions.

Ramki is working in financial services sector in Mumbai, India and is interested in investing and tracking the stock markets. Publishes a blog on Indian Stock Markets that analyses daily market movements and the factors influencing them. Views expressed here are personal.
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Indian Stock Markets Crash - Good Time to Invest


Author: Ramki


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January 22, 2008
03:41 PM

the feds have reduced interest rates by 75 bps to stimulate the market...don't remember when they lowered by such a big margin

here they dropped 25 bps

things are on a downward spiral all over...

the key query: have they bottomed?

January 23, 2008
08:12 AM

Meltdown: 'Many Gujaratis went bankrupt'

blood begets blood

Amit Patel
January 23, 2008
08:37 AM

I hope it has bottomed? How much of this is real and how much is sentimental? This is the time of global economics, and global sentiments are negative.
All the destruction that was going around the world in past few years has escalated in recent past. We need peace around the world and prosperity will follow.

The Buddha Smiled
January 23, 2008
09:50 AM

Temporal, I think that the 75 bps decline is the largest rate cut in the funds rate over the past 30 years. And while it's provided some relief by demonstrating that the Fed is willing to adopt drastic steps to counter recession, I'm actually quite concerned by the impact this will have.

Firstly, to cut rates because of stock market movements is BAD monetary policy. While the Fed under Greenspan refused to take into account asset pricing bubbles (think housing!) in the US when determining monetary policy, it looks like Bernanke's entire rationale is to shore up market sentiment. This is a very dangerous route to go down, simply because it creates exactly the sort of complacency in market participants that a truly efficient market should not entertain. By creating the impression that any price correction that aims to remedy earlier pricing distortions will be countered by aggressive rate cuts, you only incentivise even larger asset price bubbles - welcome to the world of moral hazard!

Secondly, and this is a more dangerous result, is that such aggressive rate cuts leave very little room for future movements. I can understand that Bernanke doesn't want to end up like the Bank of Japan, and not react quickly enough, but such drastic rate cuts will not leave much room in the future if more action is required (though one could argue that he could move other levers, like the bank discount rate) Also, given that the price of core commodities, including fuel and food, are at cyclical highs, the risk of entering a state of "stagflation" cannot be ruled out.

I'd agree with Ramki that the fundamentals of the EM economies haven't changed from last week; what we are seeing now is merely a factoring in of a potential US recession.

Amit Patel
January 23, 2008
01:13 PM

The Buddha Smiled,
I agree 75bp cut is drastic, but it has put breakers on falling markets around the world. Indian market bounced back around 800 points. The question is it the last time FED has to do that? Like you said there is no more room for future stock market crash. This is it. If market crashes big like this again depression is inevitable.

January 23, 2008
01:22 PM

Have you seen the US markets today?

Amit Patel
January 23, 2008
02:02 PM

Yes, down 107 points as of now.

January 23, 2008
02:09 PM

This is what happens when all markets are so closely tied to health of US economy. USA sneezes and rest of the world gets flu.

USA's consumerist economy has got no where to go. Real Estate bubble had provided a soft landing to technology bubble, but now real estate market itself is in trouble and US economy is in desperate need to find a way out to create soft landing, other wise recession in USA is a forgone conclusion. Unfortunately recession in USA means rest of the world will have to suffer too. Economy and markets have no national boundaries. India is merely a small cog in it.

Recently, NBC of USA acquired huge stake in NDTV. That means Indian media is heading towards losing its independence and become mere cog/extension of USA media and its politics. That means Indian media will have to serve American political interests. When Indian economy and Indian media become mere extension branch of USA, how long before Indian politics too become mere extension branch of USA? India will have to lobby in USA and appease American public opinion to address any local Indian interests, much like what Indians had to do during British Raj - do bidding of British Queen. Anyway, its a side issue but something to ponder over while enjoying the economic tremors.

January 23, 2008
02:40 PM

Dont rush in. Many traders are still sitting on losses and do expect volatility. As far as long and medium traders are concerned, buy in small volumes. No rush!!

Amit Patel
January 23, 2008
04:46 PM

DOW is up 298 points as of now.

January 24, 2008
02:53 AM

This was my exchange with a supply-side poster in another forum. Not really directly relevant to India or this thread. But it deals with how economic bubbles are created, what ails USA economists and welfare reformers. so here it is..

This is waterloo times for America's supply side politics that has shown pathological contempt for spending. It dogmatically thinks if there is less spending, more savings, more capital investments, somehow economy will grow and more jobs will be created. I did precisely that, spent less over years to create savings, invested my capital on couple of successful business concepts and indeed created jobs - but I had to shut down those businesses taking huge loses and terminate all jobs - because? Because there was not enough demand to keep them going - people were not able or willing to spend money even though products my businesses offered were successful franchise
concepts. I would have loved to have those welfare folks line up to buy my products with welfare checks and it would have kept my businesses
going, creating more jobs. In stead, lack of sufficient demand saw my businesses and my capital burst into bubbles.

The fundamental 101 of economy is that it is driven by demand, if there is not enough demand, businesses can not survive or grow. Demand has to
grow in order for businesses to grow and employ more people. If there is gap in supply not meeting demand, people with capital will see that as opportunity to invest, otherwise, all that idle savings and capital will be of no use to economy, it will burst like a bubble sooner or later.

When government spends money, when people spend money, when welfare checks are spent, they go to create demand for goods produced by businesses and businesses are able to grow and employ more people, investors look at demand and move into invest in more businesses creating more jobs, and jobs allows people to spend more and cycle of
growth and prosperity goes on. That is why after 9/11, Bush urged people to spend more, so economy could keep rolling. When people stop or withhold spending, that businesses come to grinding halt, and the economic cycle is reversed - businesses lose revenues, people lose jobs, people spend less because they do not have jobs or are worried about keeping their jobs, wall street reacts, stocks and investors see their money disappear into thin air - bubble created by demand-led growth bursts.

At the root of creating growth is spending/demand, and at the root of bursting of growth is lack of spending/demand. It does not matter who does the
spending, because ultimately, that money gets spent in the economy. When foreign aid or military aid is given, it is mostly in the form of credit for buying goods and services - it is to stimulate those nation's economies so they can buy american goods and services, stimulating american economy. Just because government gave welfare recipient a check does not mean that money has disappeared in thin air - that money will be go to some businesses and help those business grow.

Now, one could argue that if spending is all it takes to keep the economy growing, why don't we keep printing money and distribute it as welfare checks rather than requiring people to work at all. That would be other end of the extreme. It does not work. Economy as a whole can not spend money it has not earned by producing goods and services. When Government spends money, it is
spending money earned by people. When people spend money, they spend money earned by them by producing and selling goods and services. When welfare recipients spend money, they are spending oney earned by other people. Economy does not care who is doing the spending and who had originally earned that money - as long as money being spent is earned by somebody, economy hums along fine. So only issue with welfare spending is that of fairness and morality - why should productive class of people support people who are not productive to the economy. Such fairness issues do not make any difference to the economy, but it does to society. Does society has any obligation to look after its poor and jobless? Does an economic model that can never produce 100% employment or eliminate poverty-level menial jobs have an obligation to look after those people who are left behind? I think it does, to remain a
fair and moral society, and to remain a non-oppressive economic model, to give them a humane face. But on the other hand, one can not trap individuals in lifelong welfare or an entitlement - the welfare programs have to remain permanent fixture of government spending, but
recipients have to be hauled in and out of the system so it does not become anybody's entitlement or lifelong entrapment. America has gone from one extreme to another, but it really need a middle of the road pragmatism. In economics as in welfare, system of check and balance is needed to keep ideologues and purists in check, because if left on their own and unchecked, they are dangerous for their own world views.

In order for correction to take place, we will need pragmatists like Clintons or Macain who are apt at middle of the road blending of strengths that are on both sides. Obama on far left or any supply-side GOP nut would be a disaster for economy world-wide. I am wary of Clintons and democratic congress, creating too much clout on one side that would likely pull them towards far-left agenda which is always a home base of democrats. Giving both houses of congress to GOP will also take them on witch-hunt of democratic president like Hillary. There is no easy political way out, and markets are understandably nervous - they need a ray of hope.

February 18, 2008
12:33 AM

Dear Visitors,
This is our great opportunity to post comment on this knowledgeable and useful blog.

As we all know USA is heading toward Recession. Which is effecting movement of world markets reason being USA is major economy hub.
Now Our Budget is coming up on 29-Feb-2008 which will act as triggering movement for Indian stock market. We are expecting positive
Budget which will help the Bse and Nse to further move up. Still major support is 4200 now and on upside check out 6000 level soon.


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