Puzzles and riddles

Different views on crude prices, buying equities v mutual fund units and changing goal posts for rate cuts

By Mohan Sule

The market is a riddle. The triggers for a rally or a crash should be contradictory. Often, they are the same. Take the price of crude oil. Is the plunge good or bad for global economy? This is a puzzle for investors. A slump indicates faltering demand or excess supply. Ups and downs in consumption and prices are inherent in the economic cycle. Investors rush into a sector with a vibrant outlook. Excess capacities get built, result in a glut and a bust. The purge ensures survival of the fittest. Eventually, activity picks up and new players enter with better technology to carve out niches in the segment. Their bubbling businesses lure more investors, sowing the seeds for the repeat of history. Of late, the rules of the game seem to be changing. There is uncertainty if crude will revisit the US$100 a barrel mark. Boiling prices, hitherto, indicated a humming global economy. First, credible replacements are coming. The huge demand for the latest edition of Telsa’s electric car is a signal. Second, American businesses are investing in an alternative. Any uptick in crude price is bound to revive activity in exploration and production of shale gas. Third, Iran, an important supplier, is in the market after more than a nine-year sanction imposed by the UN for its nuclear program. All these have contributed to feeling good that oil prices are bound to remain low and stable even if consumption spurts going ahead. Yet, this scenario is a cause of pessimism. Oil producers are big consumers of goods and services. The prospects of global revival diminish if these crucial links in the consumption chain come loose.

Actions of regulators, too, fox investors. Does a light touch or cracking the whip mercilessly contribute to a dynamic market? Book building was seen as a solution to issuers’ complaints that fixed-price offerings did not factor volatility and outlook. Rich valuations, determined largely by the appetite of institutional investors, have unleashed grumblings about meager gains or negative returns post listing. Market making and buybacks introduced as safety nets to put a bottom to share meltdown have found only sporadic support. Instead of installing convoluted systems to insulate investors from the vagaries of the market, why not simply go back to the controlled pricing regime? Similarly, the capital market regulator is shepherding investors towards mutual funds as a secure mode over buying equity. Those who have opted for this method point to poor returns and high expenses incorporated by asset management companies. After tinkering with how commission should be paid, investors are now being told to deal directly with fund houses. Agents at least narrowed down funds suited to the investor’s requirement and risk profile. Bypassing distributors will mean examining the composition and track record of the scheme among other things despite warning of past returns no guarantee of future performance. If even investing in mutual fund is fraught with uncertainty and involves research, why not encourage investors to scan companies to take exposure to them? Equity trading necessarily involves signing up with a broker and so should mutual fund investing.

The third enigma is the central bank. The Reserve Bank of India has been credited with keeping Indian banks insulated from the global financial crisis of 2008, when many US and European institutions had to be bailed out and forced to merge with stronger peers. Nonetheless, many domestic entities collected huge bad assets on their balance sheets. How can a monitor be efficient as well as sleeping at the wheel at the same time? Many clients, now declared defaulters, had no problem getting additional loans despite a patchy history of servicing previous credit. Under the present governor, foreign exchange reserves have hit record highs but the local currency touched a record low.The bar for revising interest rates down keep on changing. Initially, it was the fear of food inflation due to the lethal combo of increasing prosperity and two consecutive deficient southwest monsoons. Till recently it was the inability of banks to transmute the rate reductions due to their reluctance to take risk following pressure to make higher provisions for non-performing loans. Now the cost of money will be pegged after assessment of rainfall. In the meantime, fiscal deficit is under control, current account deficit narrowing due to inflows of foreign direct investment and slowing of gold imports as jewelers downed shutters to protest the slapping of 1% excise duty, wholesale price index is in the negative for many months now and the consumer price index has come down to the comfort level of 5% and coupon on small savings schemes cut marginally. To be careful is commendable but to err on the side of caution is a misplaced zeal.