Collateral damage

The frequent bouts of market surge and fall are turning investors and companies risk-averse and will lead to political instability

By Mohan Sule

While tabulating the gain or loss of investors’ wealth following a sharp surge or a steep slide in market capitalisation, what is often missed is the unseen benefit or damage of the market’s sudden upturn or downturn. In a bear phase, investors shy off even from stocks available at attractive valuations and companies concentrate on maintaining liquidity and meeting working capital needs to keep operations running. This behavior was as predictable as the periodic market cycles. After the Great Depression of 1930s, when the stock market crash in the US in October 1929 triggered a decade-long recession round the world, the alternate swings in the market were fairly routine, with long bull phases mixed with short bouts of recession. The US basked in a bull phase for the entire 1990s. The interruption by the dot-com bust at the turn of the century lasted for about three years before the liquidity-fuelled market took stocks to historic highs. This familiar comfortable cycle got disrupted in 2008, when the mortgage bubble busted. It required the collapse of Lehman Brothers for the realisation of the downside of globalisation. The loose money policy followed by countries hurt by exposure to real estate debt resulted in flight of capital to high-growth areas rather than being ploughed into their domestic economy, hitting domestic job creation. The gusher of forex inflow bolstered currencies of developing countries, blunting the competitiveness of local enterprises and at the same time boosting the cost of inputs, fuelling inflation. Simultaneously, the unwillingness or inability of the US and many European economies to either cut spending or raise taxes ballooned their debts, culminating in a showdown in the US, with President Obama forced to agree to cut spending without any tax increases as a price to increase the debt ceiling.

Yet, after the initial panic following the downgrading of the US’s credit rating, markets calmed, taking comfort from history. Soon after the meltdown three years ago, monetary authorities around the world printed money to make available credit to industry. Governments offered tax concessions to individuals as well as companies. This time, too, the expectation is that the US Federal Reserve will undertake a third round of quantitative easing by buying bonds from the market. Will history repeat? There are some differences. First is the limited breathing space for governments, especially in the US and Europe, to announce fiscal stimulus due to their huge debt. Central banks will have to shoulder the burden of revving up the economy. Many monetary agencies in the emergencies economies are handicapped due to inflation stubbornly appending their growth as more and more of the population is lifted above poverty. Their hope lies in the market meltdown pulling down prices of agri commodities, base metals and energy. Going by past experience, their expectation may be short-lived as speculators go long on these commodities in anticipation of a bounce-back on renewed consumption by emerging economies. For developed countries, these export markets could provide an opportunity to revive their home economies. So like the 2008, when panic gave way to optimism in bust a year’s time — the recession in the US was officially declared over in 2009 — this time too the global economy could spring back sooner than expected.

At the same time, the short spells of boom and bust could permanently change the way investors and companies manage their money. Besides turning with a vengeance to unproductive assets like gold, only those with a horizon of three to five years may turn to equities. This means markets may witness short spells of intense volatility and trade range-bound for protracted periods, thereby reducing chances of quick gains. Uncertain about future direction, investors will increasingly turn to derivatives to hedge their downsides, thereby sucking volumes from the cash market. For companies, even a quarter will be too long to give guidance as markets change their complexion in days. As a result, the tendency will be to hoard cash rather than pay out dividends and become cautious while embarking on capacity expansion or acquisitions, unsure what the landscape will offer two or three years hence. On the flip side, competitors will be forced to share some services or merge to survive rather than to grow. Cost-cutting will become a recurring theme rather than a means resorted during a slowdown. The casualty will be job creation, leading to political instability around the world. The Arab spring; riots in London; the unrest in Israel, Greece, and Spain; the disgust over corruption in India; and the outrage over the high-speed train accident in China are signs of things to come.

Mohan Sule