Several records tumbled in the stock market on Tuesday as the Sensex powered its way past the 18,000 mark.
The ostensible reason for the euphoria was the decision by the Left parties not to pull the rug from under the government immediately. The upshot has been a huge surge in the market, easily making it the best performer in the region. Between 18 September, the day the US Federal Reserve cut its Fed funds rate, and 9 October, the Sensex has gained 16.4%, followed by Hong Kong’s Hang Seng index, up 14.8%, the Jakarta Composite, up 13.7%, the Straits Times, up 11.1%, the Kospi, up 9.6%, and the Shanghai Composite index, up 5.4%.
But politics is a mere excuse, just as it served as a pretext to book some profits on Monday. While an election early next year could lead to the Union budget being delayed, it will have no impact on the expenditure already passed in the current year’s budget. In fact, expenditures could well be accelerated should an election announcement be made.
In addition, the government’s share in capital formation has been falling over the years. Its share in gross fixed capital formation that was 28.4% at the turn of the century, was down to 24.6% in fiscal 2006. Simply put, the government is not the driver of economic growth. As Michael Gordon, head of investment strategy at Fidelity International, said: “While politics is supposed to make a difference in theory, actually it doesn’t.”
Perhaps the clinching evidence that politics doesn’t matter much is provided by the Thai market. After a military coup last September, Thailand’s Morgan Stanley Capital International (MSCI) Index is up 29.5% year-to-date (8 October). That’s lower than the MSCI Emerging Market Asia year-to-date gain of 39%, but well above the MSCI India’s gain of 26.7%.
What’s really happening, as Andrew Wells, chief investment officer (Asian fixed income), Fidelity International, pointed out, is that lots of money is shifting from structured investment products, such as collateralized debt obligations (CDOs) and collateralized loan obligations (CLOs), to straightforward equity products and emerging markets, with their high growth rates, which are seen as very attractive. And within emerging markets, India has been rather unfashionable and an underperformer this year, so foreign institutional investors are now making up for that by pumping billions into the market.
A Citigroup Inc. report points out that net cash taken in by China, Hong Kong and India country funds amounted to three times the amount going into other country funds in the week to 3 October. Clearly, high growth rates in China and India are the magnets drawing investors.
With the problems in the US housing market far from solved, more money is likely to flow into Asia. But what if Fed does not cut rates at its next meeting, although the Fed funds futures are pricing in a 70% chance of another rate cut at the end of October? Fidelity’s Gordon said it won’t make a difference to continuing fund flows to emerging markets.
So long as the funds keep coming in, the markets will keep rising. And in these bubble conditions, valuations are thrown out of the window.
The Sensex is now at a price-earnings (P-E) multiple of 24.85, but at a meeting held by a foreign brokerage house recently with investors abroad, their clients pointed to the 50-plus P-E multiples of mainland Chinese stocks and asked why Indian companies shouldn’t get the same valuations.
As Ajit Surana, chief executive officer of Mumbai-based brokerage firm Dimensional Securities Pvt. Ltd pointed out, “It’s the money talking.”
The rupee bounce
Everybody knows the rupee is appreciating, but how has it performed compared with other Asian currencies? Actually, while the currency has appreciated by 3.13% against the US dollar in the past one month, that’s not all that much if we consider other emerging market currencies. Compare that to an appreciation of 7.87% by the Brazilian real against the dollar, 5.16% by the Philippine peso, 4% by the Thai baht, or 3.56% by the Singapore dollar.
In a sample of 13 emerging market currencies, the rupee has been the seventh strongest against the greenback. The ranking changes dramatically if we take a six-month period instead of the past month. Over the last six months, the rupee is up 8.88% against the dollar—the second highest among the emerging market currencies, with only the Brazilian real, which appreciated by 11.75%, beating it.
The big beneficiary has been China, with the yuan appreciating by just 2.83% against the dollar in the past six months.
The Bombay Stock Exchange’s IT index is up a me-re 1.28% in the last six mon-ths and 6.99% in the past month. While expectations about good Q2 results are buoying IT stocks, the rising rupee indicates the bounce isn’t realistically sustainable.
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