The stock markets - and Pawar - get a slap in the face

The stock markets, meanwhile, are hostage to bad news and have remained under pressure because:

1. Inflation within India remains at 9% and the government keeps on saying that it should decline. And, logically, it should. The global economy is not in good shape and demand for raw materials in general should decline. This means that the prices of many products - including oil - should decline. The increase in prices of food products in India is being attributed to a change in consumption habits. As people get wealthier, they want to eat more proteins (meats and pulses) and fruits. The prices of these products will continue to increase till the farmers respond by producing more. Or systems and infrastructure is in place to make perishable products last longer. No one knows when that is likely to happen.
   
2. With high inflation comes the persistent increase in interest rates. Seeing the government sleeping at the wheel (no reforms to increase the supply side for any product or service, including agriculture), the RBI has been left the single-handed task of trying to curb demand. Hence, the persistent increase in interest rates. So there is a slow-down in demand for cars, homes, and consumer goods - much of which tends to be financed by loans. But talk to companies in the 2-wheeler, soaps, shampoos, and clothing businesses and they don't see demand declining. In fact, rural India is buzzing.
   
3. The revelation of the corruption scandals since July 2010 - Adarsh, 2G spectrum, Commonwealth Games, coal mines, gas fields, iron ore - has slowed down decision making. With the practice of granting of wealth to a few at the cost of the national exchequer increasingly under scrutiny via some courageous RTI filings, the investment by companies has slowed down. If the hard-working industrialists don't get the iron ore mines they want for free based on a few phone calls - how can they invest in all the machinery and trucks to dig out the iron ore! So, the capex numbers are down and everyone is worried. They need not be. Theft is decreasing and the country will be richer for it - the industrialist who wants the iron ore mine will now have to pay a higher price for it. And there will need to be a greater sensitivity for displaced labourers or messing around with the environment. Meanwhile, there are companies who are investing to meet the growing consumer demand. Even the small retailers, faced with a change in the FDI rules, are upgrading their stores and their services.
   
4. And politics is looking a little messy again. The Congress is leaderless and rudderless. Worse, the Congress remains arrogant in its dealing with any differing view. The BJP. Meanwhile, is running out of ideas and unable to provide a credible alternative - burning an FDI compliant shop will not help India and rath yatras are merely symbolic of the dark ages. Till the anger against corruption is taken seriously and Anna Hazare is not seen as a proxy of the RSS, slapping politicians may become a national habit. And for those in Congress who blamed the Sharad Power Slap on the BJP, it showed - once more - how disconnected the Congress is from reality. There are enough "fans of Congress" who would like to take the corrupt to task - irrespective of party lines.
   
5. Globally, the US and European economies are a write-off for the next 5 years. The willingness to take on excessive debt to satisfy current consumption (or military adventures) has been the main reason for the decline of the western economies. The cost of honouring the promises of good medical benefits and a comfortable life to retired employees cannot be met (Table 1). While the US government debt is pegged at some USD 14 trillion, private estimates put the total liabilities (including the pensioners) at over USD 40 trillion. With a GDP of USD 15 trillion and a savings rate that is less than 5% even in these distressed times, and assuming an ability to repay USD 750 billion every year with their savings of 5%, the US will take decades to pay down its debt. There is no way that the US can make good on its promises. Neither can Portugal, Ireland, Italy, Greece, or Spain (the PIIGS). That is why a "strong US Dollar" and a "weak INR" is absurd and flies against the face of rational thinking. For now, the ability of the US government to print more notes that the world wishes to buy will save it. That may change tomorrow. The buyers of US government bonds and currency notes know that they are buying a product with suspect inherent value. 

For those worried that the Indian stock markets are in a meltdown, to really understand what a meltdown is, look at what has happened to stock markets in the PIIGS (Table 2). India has had a relatively small "correction" because, as listed above, things have certainly been tough within India - and the uncertain global environment has not helped. But India is not in any sort of crisis.  

For investors, building a portfolio, my recommendation remains to keep buying - recognising the impact of weak inflows on the prices of Indian shares. Please remember that markets can turn on a dime. Sentiment - for better or for worse - can change overnight. Fear can quickly turn into greed. On March 6, 2009 the world went into a "green shoots" mode and everyone suddenly turned bullish on stock markets globally. That was only 6 months after the bankruptcy of Lehman. True, we have not yet seen the declared bankruptcy of the PIIGS or of the US as yet. So there may still be the torture of uncertainty ahead. But that is something for the trader to worry about, not the investor.

There is no fundamental change in the earnings direction of Indian companies as a universe. There is no flaw in the argument that foreign money will come into India - the unknown is the timing. There needs to be a clear understanding that the trigger of any share price movement is a function of foreign flows.

Accepting this fact, in the final analysis, every investor must identify his or her risk taking ability: a portfolio allocation decision - how much money to invest in the stock markets and how much "downside" pain can they endure by seeing all the gloom and doom and red numbers on the business TV channels (my solution: switch off the TV channels). There will be - and there has been - downside pain. Markets can fall suddenly - it is not easy to see your initial investment of Rs 100,000 in a mutual fund lose 25% of its value in a year! But an investor would not panic and would check the facts: on earnings and on flows. These are the reasons behind any potential rise in share prices.