In 120 blistering seconds of trading on Monday, investors in Indian equities blew away dark doubts built over several months—and participated in an unprecedented buying spree. Is this a case of irrational exuberance?
The major equity index soared by 2,110 points in two short bursts of a minute each, as one of the biggest fears hanging over the city dissipated over the weekend.
Illustration: Jayachandran / Mint
The thumping win of the Congress-led coalition and the equally decisive loss of the Left cheered the market. Investors had made it clear over the past few weeks that they preferred a stable government led by one of the two national parties rather than a ragtag one held hostage by the Left. A stable government unencumbered by anti-reform groups is likely to set the derailed economy back on track, they believe.
It seems almost unsporting to splash cold water in the face of such heady euphoria. Value investing guru Benjamin Graham was quite correct when he described the stock market as a voting machine in the short run and a weighing machine in the long run. On Monday, we saw it work like a voting machine.
Long-term investors need to worry about how it operates as a weighing machine as well. Equity valuations are eventually a function of factors such as economic growth, corporate health and the interest rate at which future earnings are discounted. Going by recent information, we doubt the current valuations of companies can be justified.
True, going by forward-looking data such as purchasing managers’ surveys and financial conditions indices, there is reason to believe that the economy will stabilize and perhaps even accelerate later this year. It is also highly likely that the Indian economy will bounce back earlier than most other major economies.
But the new government still has a lot of hard work to do and companies have to repair the damage to their financials. And there is always the chance of further global shocks in the months ahead. The stock market seems to have ignored all these obvious risks in its rush to celebrate.
It is best to rewind to 17 May 2004, when equity prices crashed once it became clear that the United Progressive Alliance government would need support from the Left to survive. That was the voting machine. But what followed was a huge bull run powered by high growth and record profits. That was the weighing machine.
The market is likely to ride this euphoric wave for some time before harsher economic and financial realities set in.
Is this irrational exuberance? Tell us at firstname.lastname@example.org