How Markets really work

2.1                                                          STOCK MARKETS        

Explore a framework for how markets really work

The prevailing paradigm for financial markets that markets tend towards equilibrium and deviations from it are random is both false and misleading. The legendary market man George Soros argues that only by exploring a new conceptual framework for how markets really work can we avoid disaster and economic ruin. The present global crisis is not an account of market misconduct but the result of deliberate leveraging, mis-pricing of risk and asset bubbles. Although several confidence-building measures have been taken, we may not have come to the end of the tunnel.

Fears of a US as well as global recession will not die down so soon. It is important that this is understood and we should not get carried away merely by the performance of the stock market or the other emerging positive news and considers them as indication of prosperity. It is important now that we take a deep dive to clean up our own house by taking deeper systemic measures.

George Soros in his analysis of the crisis laments that in the financial markets we have to make decisions without having sufficient knowledge at our disposal. He also states that we have, to an extent gained control over the forces of nature and that makes us powerful. Our decisions have great impact on nature. We can do a lot of good or a lot of harm. However, we have not learned how to govern ourselves. As a consequence, we live in great uncertainty and grave danger. We need to gain a better understanding of the situation in which we find ourselves. It is difficult to accept uncertainty. It is tempting to try and escape it by kidding ourselves and each other, and that is liable to land us in greater difficulties.

Looking back: 17.5% rally of sensex in April 2009

April 2009:Globally markets continued their smart run on better than expected quarterly earnings numbers from several corporates which subdued the impact of emerging gloomy economic data. Domestic markets continued to display strong buoyancy during the month with Sensex posting a whopping 1,694.75-points-gain. The sentiments continued to remain encouragingly positive on the back of continued strong liquidity momentum aided by FIIs. The FII inflows in April 09 has totalled Rs 5,560 crore, reversing the trend in first three months of the Calendar Year 2009, during which FII outflow was as high as Rs 6,672 crore.

1^st week of May 09 Sensex up 475 points (4.15%), in ninth week rally

Sensex zooms 732 points on Monday, to close above 12,000

Indian shares surfed the wave of bullishness in global equity markets to post their biggest single day gain in six months on Monday despite some concerns that hopes for a speedy economic recovery may be just frothy optimism. The Sensex rose by 6.4% or 731.5 points, to close at a 7-month high of 12134.75. The extreme chaos of 2008 seems to be behind us. Till last month, players were comfortable with the price, but were wondering if it was the right time to buy. Now the consensus seems to be that it is indeed the right time. The popular belief is that a recovery in China will help pull the global economy out of recession by creating demand. Economic parameters would increasingly get better hereon.

There are murmurs that some of the unaccounted money parked in Swiss banks could be returning home, fearing tighter banking regulations in future. A decent chunk of overseas money that has flowed into equities over the past few weeks has been coming through the P-note (participatory note) route, and there is reason to believe that a good portion of this could be unaccounted money finding its way back into stock markets. Investors, who do not want to take exposure to India directly, invest through registered FIIs, which invest on their behalf and issue P-notes as shares cannot be held by unregistered portfolio investors. Sebi had put curbs on P-notes in 2007, but later revoked it last year.

STOCK MARKETS

Indian stocks are out of wood

The 17.5% rally of the Sensex in April 2009, the best monthly rise in a decade, followed by 6.42% surge on Monday would give the impression that Indian stocks have come out of the bear market. Many analysts have suggested the stock markets were at the beginning of a bull rally. The temptation to believe Indian stocks are out of the woods would be high, as sentiments in the market seem to have turned positive. Macro indicators coming out from many economies give the impression that the worst of the economic downturn is behind us. Chinas manufacturing has rebound for the first time in 9-months. In the US, the pace of decline of factory output has slowed. And in India, industrial output expanded for the first time in 5-months in April according to ABN AMRO Bank purchasing managers index.

The Sensex extended its rally to 9-straight week, gaining another 475 points, making the longest weekly rally since July 24, 2006 with a rise of 42.65%, and the biggest weekly %-wise gains in the BSE history. 

Sentiments have improved

FIIs have always had a strong influence on Indian markets. The markets fell by around 60% between January 2008 to March 2009 when FIIs withdraw around $25 billion from the Indian markets. While the domestic Institutions were net buyers with around $18 billion in this period, the ownership structure has become much more balanced now with both domestic institutions and FIIs owning roughly $80 billion each worth of stocks. The FIIs were largely selling while the domestic institutions have been regularly buying. Now that the FIIs have also turned buyers, having invested close to $1.5 billion over the last month, the sensex has recovered nearly 50% from the recent lows. Should the trend continue? A significant negative surprise in the Indian election results on Saturday (16/05/09);

2^nd week of May 09 Sensex up 295 points (2.48%), in tenth week rally

Sensex zooms 475 points on Tuesday, to close above 12,000

Indias industrial output recorded its sharpest fall in 16 years in March 09 and exports fell for the seventh straight month in April 09, but that did not prevent local stock markets rallying to a seven-month high on Tuesday, propelling by a surge in fund flows as investors positioned themselves ahead of the election results this weekend. Market appeared to have its focus firmly on the future; with analysts and economists predicting a recovery was imminent.