Many of my friends ask me whether the market still go down or when it start consolidating or start to surge? But being a newbie of just one year old how can I judge when people like our PM Mr. Manmohan Singh, and SEBI chairman C. B. Bhave are not able to say anything. Yes market is like that. Everyday we are facing some new crisis, new bailout, job cuts, recessions, drop in interest rates & etc. So nobody can predict the market movements in this kind of crisis time. So here is what Mr. Bhave is saying...
Let me begin with the problems that the world is facing today. In August 2007, the United States (US) and the European markets had discovered that their financial institutions were carrying on their books assets which came to be known as sub-prime assets of which they had no idea of how to value.
The whole thing came up when one of the banks in its quarterly report said, “I do not know how to value my book.”
That created a fear in investor’s minds that all these balance sheets and profit and loss accounts may just be a story and which required more reading into. They feared these numbers did not reflect the actual state of affairs.
After August 2007, till January 2008 Indian market kept booming. So a theory developed around that time that we were decoupled from the Western economies and India was relatively in isolation and would charter its own cost.
Our focus of attention was essentially on the stock markets. Then the market had some shocks in January then saw some recovery and in subsequent months saw a fall again and so on. Till September 15, when one of the biggest US financial institution, Lehman Brothers was allowed to go bankrupt, we had not realized how closely linked with the world we were.
Even on September 15 Indian did not realize the profound effect it would have on the economy. Interestingly even the Western regulators did not see this recession.
This effect was not on the stock markets, the effect was on the credit markets.
One of the things we probably missed out is the importance of credit markets in the world.
As Lehman went down – there was already this fear for a period of one year in the minds of investors of whether balance sheets portrayed a true picture of the bank properly or not. Then, another peculiar thing happened i.e. institutions stopped trusting each other.
So if a bank doesn’t trust another bank then credit markets cannot function and if credit markets don’t function then trade and commerce is impossible.
It took us about 15-20 days to realize how closely interlinked with the world we were through the credit markets because our trade credit got affected, some of the companies were raising even their working capital requirements on the international markets. We started having the phenomena of these companies wanting to raise the same money in the Indian markets and we had a huge liquidity squeeze and two shocks in October when we went through a liquidity squeeze.
This resulted in an impact on the mutual fund industry because all corporates then wanted to withdraw from the liquid schemes of mutual funds.
The mutual funds in turn found that their underlying assets had no markets because nobody had money, so nobody was going to buy these assets. So we had to take some emergency action. The basic point I want to make here is that we are very closely interlinked with the world even though we are not a capital account convertible country and therefore the capital linkage is not so much but the linkage through trade is tremendous.
Since short-term capital got affected in this manner and credit market seized, the question for us to ask is why did something similar not happened in the equity markets? Why did people not lose faith in each other and why did they not stop transacting? The answer takes us back to the question that probably equity markets are organized far better.
These are exchange traded markets and these markets have what all called clearing entities. These clearing entities take the counter party risks.
Therefore when a broker puts a trade on a stock exchange, he does not worry as to who the counterparty broker is. He knows that at the end of that day, the clearing corporation is my counterparty and that clearing corporation holds enough money by way of margins and a guarantee fund to be able to complete that transaction.
It is through building this infrastructure, these clearing corporations didn’t exist in our markets ten years ago, it is in the last ten years that this country has acidulously built these clearing corporations, the regulator has required and the market has responded by adequately creating big enough settlement guarantee funds and the ability to give this counterparty guarantee a margin mechanism which hasn’t failed despite the fact that more than 50% of the index is off.
The point I want to make with reference to this crisis is that this is an opportunity for us to study what went wrong not because we want to pin the blame on X, Y or Z or be happy that some developed markets made mistakes and we are great. But to study this phenomenon in order to learn as to what do we need to do when we become as big as them. Do we have the institutional capacity to handle these things and if we don’t what efforts do we need to make?
The bank said ‘I do not know how to value the assets in my book’. So when there are over-the-counter trades as opposed to exchange trades, prices are not transparent and when prices are not transparent, it is not possible to create a clearing agency which will clear this trades with the guarantee that irrespective of who your counter party is I will put this trade through.
So to my mind our effort as regulators, as systems, as market player should be to see that we take as many financial products as possible on to an exchange traded market.
One of the small beginnings that we have made in this direction is to bring currency futures on to the exchange traded platform.
As far as what investors need to do in such markets; the first principle of markets is that if they are really true markets then nobody can predict how low or how high these markets will go. So if somebody tells you that I always knew that this market will go up to 21,000 in the month of January and thereafter fall then he is only being wise after the event.
If he was asked in January whether this will happen, he wouldn’t have been able to predict. If you ask him today how low the market is going to go and when and when will it start rising, again we do not have an answer. Many times we tend to forget this.
Nobody can predict whether the market will go up or down tomorrow.
So, in short, equity investment is a risky investment. When you say that this is risky investment, what is the first thing you do as an investor? The first thing is, please do not put all your savings into the equity market.
Since you do not know when it going to go up or go down, you also cannot time the market. So, that means do not put that money that might be required by you for an emergency, because if you put that money into this market, you might have to withdraw it at a wrong point from your perspective. You might have to book losses and withdraw that money.
Last but not the least, do not leverage yourself and invest into the market. This is precisely what happens when the market is going up. When the market is going up and we see it going up every day for months together, we think that it is a one-way bet.
If I bet Rs 10 on this market, in one-month I’ll get Rs 11. That sounds like a fantastic return. I have Rs 10 in my pocket. But then I see, if I borrow Rs 90 more and put Rs 100 in this market that would be even more fantastic returns. I’ll earn Rs 10. So, on my Rs 10 I have a return of Rs 10. I would be a very wise person.
But you forget in the process of leveraging that if you had a loss of Rs 10, then your entire contribution is wiped out. The remaining Rs 90 would have to be returned to the person who lent you that money. This is not just for retail investors. Retail investors should certainly not do it. But even institutions should not get into this. That is the second lesson we have learnt from what happened in the western markets.
You must have read that the five biggest firms in the US went in 2004 to the Securities and Exchange Commission (SEC) and asked the committee to relax the net capital rule for them because they are big institutions. They said they knew how to conduct our risk management practices. The Commission was convinced and it made an exception in the case of these firms. Those firms took their leveraging to 1:30. Now we are being told that the deleveraging process is on and therefore money is being withdrawn from global markets and not just our markets.
So, leveraging is a very dangerous thing. Trade and commerce cannot run unless you leverage yourself. So, the trick is in balancing.
Every crisis is an opportunity. We have learnt a lot during the month of October. We should use this opportunity to improve our system. When the chips are down, we must build for the future, and not just be unhappy that the chips are down, because this country will recover most probably amongst the fastest in the world. We will feel the effect of what is going on in the world but we will be amongst the first few that recover. When we do recover, our weight in the world will be more than what it was before the crisis.
No comments:
Post a Comment