What the market knows

The stock-surge that is discounting the lag effect can be torpedoed by richly-valued IPOs and governance issues

Mainline indices galloped amid evidence tumbling out of the economic slowdown worsening. An optimistic outlook might have justified the surge. That is not so. Global and domestic institutions seem to be in a race to slash growth forecasts. The divergence in the market’s behavior from ground realities should ideally be a cause of concern. It is not for two reasons. First, the market is aware of the lag effect. The inflow of foreign funds, fattened on the profit skimmed from the US markets recording new lifetime-peaks, has benefited mainly large and mid-cap biggies. The liquidity that will come from booking capital gains will percolate to small caps. As such, there is scope for front-line stocks to let off steam without causing an all-round collapse. Second, the underlying stress is providing a trigger to restructure the economy. The reduction in the base corporate tax rate to 22% has placed India among the most competitive countries to attract FDI. The big-bang reform is comparable to the opening up of closed sectors to private investment by the cash-strapped Narasimha Rao government in the early 1990s and setting up of a divestment ministry by the Atal Bihari Vajpayee government in September 2001 following the dot-com bubble burst at the turn of 2000. Now the Narendra Modi government might be giving up control of banks and withdrawing from the oil and gas sector. Unlike rating agencies basing their projection on past performance, the market is discounting the path the Modi government is going to travel to make India a US$5-trillion economy. Standard & Poor’s seems to have read the signals correctly. It sees India outperforming its peers going ahead.

The market recognizes that some companies can outperform the country. Reliance Industries is hitting new highs irrespective of gloomy macro indicators. The Bajaj financial services twins are in a fine fettle even as the NBFC space is struggling. IPOs of IRCTC, India Mart InterMesh, CBS Bank and Ujjivan Small Finance Bank got good response despite risk-aversion. The market is sensitive of the collateral damage caused by governance issues. The IL&FS default has had a cascading impact on lenders including companies, banks, NBFCs and mutual funds. Heavily-leveraged DHFL has become the first financial services firm to undergo the resolution process. Promoters of Yes Bank and Zee had to shed stake and management control. The issue of divergence in reporting of bad loans turned off investors from private banks. The market’s distaste for small caps lingers more than a year after the auditor of Manpasand Beverages quit, setting off a chain of resignations. In a throwback to Satyam Computer Services’ accounting scandal, the board of CG Power and Industrial Solutions confessed of manipulations by its head. The market fears whistle-blowers for the wealth destruction they inflict. The recovery of Infosys, Indiabulls Housing Finance and Sun Pharmaceuticals has not fully made up for the value erosion caused by allegations of malpractices. The market is watching how the issue of misuse of client funds by stock broker Karvy is handled by the regulators as such scams can put off investors for a long time as happened after broker Ketan Parekh was found in 2001 to have manipulated prices of 20 stocks. The market knows that the standstill agreements executed by mutual funds, allowing borrowers to roll over their repayment and quarantining such paper, have resulted in loss of confidence in debt funds.

The market is aware that the frenzy in the primary market can result in a stampede to exit if a richly-valued IPO disappoints. Reliance Power debuted in February 2008 at a 17% discount and never ever crossed the offer price. It accelerated the meltdown of the primary and secondary markets that was gathering speed as the housing mortgage market in the US was coming under increasing strain. The market has realized that the world is flat. The over year-long US and China trade-tariff tiff and the tortuous course that Britain is taking to exit from the EU are overhangs on the direction of the global economy. Central banks have to track the Federal Reserve’s moves to determine their policies. Would the Reserve Bank of India have taken a pause if the Fed had not hinted that it would not undertake any more rate cuts next year? At the same time, the market has now understood that inter-connectivity and supply-chain links are fragile. The US has demonstrated that an inward-looking economy can triumph over free trade. Not surprisingly, India’s rejection of the Regional Comprehensive Economic Partnership, covering the Asia-Pacific region, did not create any ripples in the market.

-Mohan Sule