Bulls on top, but bears lurk below : Financial Express 9th September 2009

The bath tub inspired not just Archimedes but also Alan Greenspan who coined the phrase ‘irrational exuberance’ centuries later in 1996, before he had to deliver his black-tie dinner speech titled ‘The Challenge of Central Banking in a Democratic Society’ at the American Enterprise Institute in Washington. It is now well known that these words brought down the markets in Tokyo and Hong Kong by 3%, London and Frankfurt by 4% and the US by 2%. We are, therefore, careful with words today. But, these words would really best describe what we are seeing in BKC (Bandra Kurla Complex where NSE is located) and Dalal Street (which houses BSE) these days. The Sensex has soared to cross 16,000—this mark has been reached after 361 trading days; it was last seen at this level on 2nd June 2008. Since April 1, the Sensex had soared by 62% to reach 16016 on the 7th of August (16123 on 8th) while the Nifty has gained 56%. Those who back stock markets as being reflective of true sentiments would say that conditions are looking bright with a monsoon revival, commitment of the world to move out of the recession, foreign funds gushing in and IPOs meeting with stupendous success. Stock market movements are always justified to reflect developments that may be coincidental. That is how the spirit is kept up and that’s how money keeps moving the market in a certain direction. We already have broking firms pointing at the sky because by doing so the sentiment is built up and people invest more, thus keeping the spiral moving. It should be remembered that markets boom when more money pours in. This is not so much fresh money being generated but merely transfer of funds from buyers to sellers in such a cycle. There is no new wealth being generated as such and hence the basic question is whether or not this is sustainable? To answer this question we need to check the factors that may be causing the indices to increase—the fundamentals. The economic fundamentals have not changed, and while growth has been encouraging in Q1, the government has admitted that growth in Q2 and Q3 would not be that good. The monsoon has failed and it is now accepted that farm output will be down and inflation higher. In fact, even as the possible drought scenario had spread from the beginning of... July, the Sensex had bounced by 9.4% till date. Further, the Sensex has climbed by 5% since 21st August when the FM uttered the dreaded D (drought) word. This really means that monsoon news does not matter for the stock market. If this is so, then the news that there has been a revival of the monsoon cannot be a factor driving sentiments. Against this backdrop one could expect fiscal intervention—the fiscal response will entail outlays that can impact the deficit as well as interest rates ultimately. Hence the near-term environment is not too conduciveto enthusiasm. While industry has shown signs of growing, corporate profits in Q1 are more due to cost cutting and weak commodity prices rather than topline growth. And given the present upward trend in commodity prices, such a scenario may not be sustainable. Also growth in credit so far has been tardy and does not warrant euphoria. The other factor which has been quoted as being responsible for these price movements is that foreign investors are taking greater interest. However, this is not really borne by Sebi data which shows that in September so far, there had been an inflow of just $ 19 million in equity up to 8th September. The impact of the G20 resolution to continue with the economic stimulus measures also needs to be viewed with caution. The fact that all countries are keen to move out of the recession was known to all as governments and central banks have provided several relief measures to their financial sectors as well as invoked tax cuts and enhanced expenditures to keep their economies moving. Hence, the present resolution is only a continuation of a resolve and not any specific measure(s) to actually provide a further boost to the world economy. Lastly, the success of IPO is a bit contrived. A bull market run by irrational exuberance instills faith in investors who go out shopping for deals, and IPOs provide an option. The absence of alternatives with interest rates being low has made investors turn to the bourses. All this means that while the present impetus may be attributed to positive sentiments emanating from various announcement effects, the underlying conditions do not appear to be too sanguine in terms of growth or inflation. The fundamentals as of now do not inspire confidence and there is a limit to which sentiment, either rational or irrational,can keep the spirits up. A correction may be expected soon.