The new trading year starting Tuesday, Samvat 2065, could hardly begin in less auspicious circumstances.
Friday’s bloodbath on the bourses showed that despite all the money being thrown by central banks at the credit markets, deleveraging continues in full force. Although several frontline individual stocks have lost at least three-quarters of their value, that didn’t prevent them losing another 40-50% on the panic selling. Redemptions by hedge funds and other foreign investors led to this latest bout. And, the selling has been indiscriminate: commodities, gold, oil and real estate prices have all been falling as the huge amount of leverage built up during the boom years unwinds. As many commentators have pointed out, it’s a global margin call.
The market has lost around the same amount in percentage terms as during previous lows. This, however, is no mere cyclical downturn, but the unwinding of one of the greatest speculative bubbles the world has ever seen. The entire “shadow banking system”, the inverted pyramid of exotic derivative products that multiplied leverage many times, is fast disappearing and with it, the liquidity the products helped create. This is one reason why liquidity is tight despite the huge amounts pumped in by central banks and governments. The other problem is a crisis of confidence, as investors realize the magnitude of the disaster.
Emerging markets, the big beneficiaries of the excess liquidity generated by the shadow banking system, will clearly suffer on account of its disappearance. With the flight of capital, emerging market currencies, too, are under pressure. This severely hurts companies that borrowed abroad. Central bank intervention to shore up currencies leads to further deterioration in liquidity and to a credit crunch. The real economy slows and earnings growth for companies is thus lower.
Illustration: Jayachandran / Mint
Are we near a bottom? It’s true value has emerged in several stocks. But the Indian market is a mere sideshow, a reflection of events in the global markets. What matters today is not valuation, nor the success stories of individual companies, but liquidity. Investors should wait for the return of a modicum of stability before they start considering valuations. True, they may miss a few bear market rallies, but few retail investors are nimble enough to benefit from these sharp pull-backs. They would do well to preserve their capital instead. As economist John Maynard Keynes said, markets can stay irrational longer than you can stay solvent.
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