Events & Market

On July 6th when the Finance Minister, Pranab Mukherjee started his budget speech, India Inc. was glued to the television set. With a stable government minus the Left at the Centre, everyone expected a reform-oriented budget. But the budget was a total disappointment for everyone. The market reacted in a knee-jerk fashion and the BSE Sensex tanked by 5.83 per cent from its previous closing, recording a drastic intraday fall of 1054.47 points or 6.98 per cent (from its intra-day high). Thereafter, the Sensex touched the level of 13219.99 on 13 July, recording a fall of 11.35 per cent from its pre-budget close and closing in the red for four consecutive trading sessions.However, the Sensex recovered to the pre-budget levels in just 10 trading sessions. Till date, after 15 trading sessions, the market has gained over 9 per cent from the budget day close, and a huge 16.30 per cent from the post-budget low. So what changed in the last 20-odd days that the market had swung so wildly from about 13,000 to 15,000 levels? So what events and factors move the market? DSIJ looks at events and factors which impact the market – albeit in the short term – including geopolitical situations such as terrorist attacks, war and elections, corporate scams like Satyam, major IPOs sucking out liquidity from the equity market, movement in the commodity prices, global financial market situation such as the collapse of Lehman Brothers leading to the financial turmoil in the US.

THE 3 ‘E’s
Basically, there are 3‘E’s that move the markets: Earnings, Emotions & Events. We have already touched upon briefly the third ‘E’ of ‘events’ above and will elaborate on it later. Now, let us first understand the other two ‘E’s that affect the equity markets. The first “E” factor is fundamental and stands for “Earnings”. This factor spells out the stock price in relation to the company’s earnings – which tells you, in general, whether a stock is cheap or expensive.

However, it’s the second “E” factor, i.e. “Emotions” that moves and shakes the market in a crazy way – such as we saw post-budget. These emotions are mainly greed and fear, where greed prevents retail investors from taking advantage of a rising market and fear makes them flee away from the market when they should be flocking to buy.

The fundamentals of the companies do not change everyday, yet the share prices move up and down daily. This volatility is due to the third ‘E’ which stands for ‘events’. Events impact emotions or sentiments in a positive or negative way. Not only the events per se, but also how these are presented by the media impact the sentiments. Based on the presentation and interpretation of the events, people make decisions by taking short[PAGE BREAK]

cuts without processing the information (known as heuristic in the behavioural finance) based on how quick the information is received.“

We have a herd mentality in the market and when we don’t understand anything in the market, we try to do things that are done by majority of the people so that, if we go wrong, we will have the solace that everyone has gone wrong. The effects of events on the markets are basically short-lived, unless these have long-term implications,” says Parag S. Parikh, Chairman, Parag Parikh Financial Advisory Services.

Markets are rational in the long run, however, the events and their effects turn the market irrational in the short run. So, if you remain rational when the markets are behaving irrationally, you can make money. To put it simply: buy when everyone is selling, and sell when everyone is buying – kind of value buying. But this is easier said than done. “People are not actually rational and the reason is that we have a mind and a heart. We are supposed to make decisions with our mind but if decisions are made from the heart, then they may not be of financial interest and that is the crux of the financial prospect theory of behavioural finance. Good decisions are always made when there is less noise, so one should not always follow the ticker and the news channel,” advises Parikh. Now let’s look at some of the events which have an impact in the short term.

MONSOON
The monsoon doesn’t impact the equity markets directly, but it has deep implications for the growth of economy. Deficient rainfall has the double whammy effect on the economy, as it not only leads to higher inflation, but also adversely impacts the overall demand in the economy. Deficient rainfall results in decline in agricultural produce, which hugely impacts the food prices in a highly populated country like India, pushing inflation at higher levels. Agricultural activity hugely depends on good monsoon and contributes 15 per cent to the GDP and massive 60 per cent of total employment. As majority of our population’s earnings depend on agricultural activity, it directly impact the prices of commodities and indirectly affect demand in the country.

BUDGET
Since 1993, out of 17 occasions, market has tanked on the budget day 11 times. This is because the capital market players eagerly await the Union budget with lot of expectations. Every industry, investor or an individual would expect the budget to bring goodies for them. The expectations are infinite but the means to satisfy them are limited, so not everybody can be pleased. Thus, for most of the times, large part of these expectations go unfulfilled.

During P Chidambaram’s ‘dream’ budget of 1997, the markets rose by an impressive 6.53 per cent on the budget day, which is highest rise in the last 17 years. The budget laid down the road map for economic reforms in India, lowering income tax rates, removing surcharge on corporate tax and reducing corporate tax rates. However, as explained earlier, the impact of the budget has always been short-lived on the market.[PAGE BREAK]

ELECTIONS
When the Lok Sabha Election’s results were announced, the market went euphoric and rose by whop-ping 17.34 per cent and hit the upper circuit after the ruling United Progressive Alliance’s (UPA) returned to power. The UPA winning by a clear majority meant political stability at the Centre without the Left parties which were perceived to be anti-reforms. The markets and most political pundits expected that the 2009 elections would throw up a hung parliament and, therefore, an unstable government at the Centre, but the election results gave a pleasant surprise for the market and within a month (April – May 2009), it went up by 28.26 per cent. Political stability is good for the growth of the economy and for the equity markets. However, election results earlier have not too good for the market. Since 10th Lok Sabha elections, i.e. out of six elections, the market has rejoiced only twice on the outcome of the elections and been in the positive zone. Markets had gone up by 10.32 per cent in one month after the declaration of the 12th Lok Sabha election in 1998, where BJP won maximum seats. The rise in the market on both these occasions means that the market rejoices on prospects of political stability irrespective of which party comes to power. As against this, the market on the other four instances went down mainly on account of political instability. For example, after 2004 election results, the market fell by almost 16 per cent in one month and by 6.10 per cent on an intra-day basis due to political uncertainty in the wake of UPA coalition coming to power with outside support of the Left parties.

Of course, in the long run, elections do have long-term implications for the economic growth of a country, but like other events, electoral outcomes do impact market sentiments in the short-term but do not have a long-term impact on the market.

TERRORIST ATTACKS
It may seem rather surprising that our markets have managed to take major terrorist attacks in their stride. For example, the March 12, 1993, serial bombings took lives of about 250 civilians and left 700 injured, but the market went up by 2.66 per cent, despite the fact that one of the blasts took place right in the basement of the BSE building. The serial bombings of July 11, 2005 in the crowded Mumbai trains which claimed 209 lives saw the Sensex rising 3 per cent. However, the 9/11 attack on the World Trade Centre in New York had major impact on our markets. The market was reeling under the impact for 45 trading days. The terrorist attack on the parliament too had deep impact which lasted 15 days.

However,even if we consider the impact of 9/11, the BSE Sensex went up by over 19 per cent within 6 months (till March 04, 2002) of the terrorist attack. So, despite such a major attack, markets took only 45 trading days to recover. Even during the Kargil conflict in May-July 1999, the [PAGE BREAK]

markets ended in green for consecutive four months starting May. So, the geopolitical situation does not have long-term impact on the stock market, but such tumultuous events do affect sentiments in the short-term.

CORPORATE FRAUDS & SCAMS
The Satyam Computer scam which surfaced in January ’09 shook India Inc. to its roots. The immediate impact of this was felt in the market. After relentless fall from September 2008 to November 2008 after the shock of Lehman Brothers bankrupt-cy, the Sensex was barely up on its feet in December 2008 (+5%) when it fell by three per cent in January, 09. However, this did not bother the Indian investors for long and it took only 56 trading days to reach pre-Satyam scandal levels. But the first major scam to hit the Indian market was the Harshad Mehta scam which got unearthed in April ’92. The market fell about 43 per cent from its high of 4,467 in April 1992 in the next four months and took almost 28 months to recover. Even after this scam, there were other frauds and scandals that kept spooking the markets but none of that had any lasting effects. Some of the prominent among them were C R Bhansali and cobbler scam in 1995 and the Ketan Parkeh scam of 2001. However, the effect of international corporate frauds like Enron, World.com and fall of Lehman Brothers has been quite profound on our markets.

COMMODITIES MARKET & SENSEX
The stock markets and the commodities markets have been often compared and this has become especially important when both of them have seen a good run in the last five years. While stock market has always been an attractive asset class, commodities too is seen as an attractive investment destination, especially crude when it touched an all time high of $147 per barrel last year. In fact, during this period many believed that crude was the next big investment destination, when equity was losing its sheen.

But the moot point is: has the commodity market outperformed the stock market? Also, does the commodity cycle really impact the stock market? To get more insight on the same, we compared Sensex performance with the Commodity Research Bureau (CRB) Continuous Commodity Index (CCI) for the commodity market performance. The CCI was originally designed to pro-vide dynamic representation of broad trends in overall commodity prices. This widely accepted index now comprises of 17commodities, which includes six groups namely energy (weightage 17.6 per cent), grains and oil seeds[PAGE BREAK]

(17.6 per cent), industrials (11.8 per cent), livestock (11.8 per cent), precious metals (17.6 per cent) and softs such as sugar, coffee etc (23.5 per cent).

We analysed data from 2004 onwards, which was more or less the start of rally for both commodities and stock market. The study made a startling discovery and indicated two things; firstly, the commodity cycle does impact the stock market, which has more of a lag effect and, secondly, barring once, the Sensex has always outperformed the commodity index. Surprisingly though, Sensex had initially underperformed the CCI for more than a year i.e. from Jan 2004 till May 2005. But from June 2005 onwards, the Sensex started to outperform the commodities market (see graph). In fact, while the CCI index shows a more secular movement, the Sensex movement has been more volatile followed by a sharp rise, thus increasing the gap between the CCI and Sensex from July 2005 till December 2007, when the Sensex returns peaked. However, as the commodity rally picked up pace and peaked in June 2008, the Sensex had already started to correct sharply. This was on account of sub-prime crisis, hardened interest rates, inflation and last, but not the least, the lag effect of the commodity cycle. But despite the correction, the Sensex still out-performed the CCI. In fact, post the consolidation in both, Sensex and CCI during November 2008 - March 2009, the Sensex has once again given sharp bounce back and returns, while the CCI has failed to keep up with it and seems to be slipping down. This clearly indicates that though we saw a sharp spike in commodity prices, it had a delayed impact on the stock market. However, despite this event, the Sensex has always managed to outperform the commodity market.

LONG-TERM CAGR MAKES A DIFFERENCE
It’s often said that “Market is always good for investments with a long term objective” and if we take a look at the compounded average growth rate (CAGR), the statement stands vindicated. Our study clearly suggests that long-term investing is lot less risky and causes less stress even while bringing in profits much higher than the risk-free returns. To study the phenomenon, we have taken the maximum available data for Sensex and various scrips, then adjusted it for splits and bonuses and calculated the CAGR for that many years. It is evident that maximum scrips have provided better returns than risk-free returns. However, our returns don’t include the dividend investors would have received during the period. If one considers the same, then the returns would go up further.[PAGE BREAK]

To quantify the impact of long-term investing, in the last 29 years, Sensex has showed a CAGR of 18.12 per cent. In comparison, out of 79 companies in our universe, 40 companies have managed to outperform the Sensex. There are around 21 counters that have failed to outperform the Sensex, but the returns are surely bet-ter than the risk-free returns. So with 61 counters providing better returns than risk free investment, it is quite clear that long-term investment in equity provides better returns.

Yes, it is also true that not all long-term investments were good and some have eroded value of investments, but these were few counters. Only 18 companies have given a CAGR of less than 10 per cent, while just 5 providing negative returns. But again, we have not included dividend, which may slightly improve the performance.

Further, many interesting facts emerged from this study. The first surprising fact is that while index heavyweight Reliance Industries is supposed to be a major wealth creator, the data shows that RIL has underperformed the Sensex, as after all the adjustments, it has provided CAGR of 15.72 per cent (23 years), whereas during the same period, the Sensex have showed a CAGR of 17.44 per cent.

In sectors like automobile and IT, the leaders have managed to outperform the others in the group by a wide margin. Like Infosys has showed a CAGR of 63.67 per cent in 15 years and the second best Mphasis is only at 47.97 per cent in 14 years. Similarly, in the case of automobiles, Maruti, Hero Honda and M&M have managed to perform better, while others lag much behind. So this performance suggests that, it is better to stick to industry leaders in the long term.

But again the rule does not apply to commodity sectors like cement and steel, where the others have managed to outperform the leaders. In steel, Jindal Steel has provided CAGR of 67.85 per cent (10 years) much ahead of Tata Steel (14.13 per cent) and SAIL (6.19 per cent). Similarly in cement, Shree Cement has outperformed the market leaders.

The oil companies have been the poor performers. While returns from BPCL and HPCL have been less that risk-free returns, ONGC and IOC are just few points above the 10 per cent mark. After looking at the performance of oil companies, it clearly indicates that it is more on account of government policies and not their performance.

FMCG sector is considered a defensive play, but if we take a look at the returns from the FMCG counters, the sector seems to be a much better play in the long term as, except two counters, all other counters have managed to beat Sensex. Although not much movement has been seen in the sector in the last few years, we feel the law of averages will help the sector catch up with other sectors.

As for cement sector, despite being cyclical in nature, the returns from the sector have been really good. So it is quite evident that even sectors with cyclical nature have performed well in the long run. Power sector has also provided good returns, with the returns being almost similar from all companies. Surprisingly, Suzlon which is treated as a growth stock, has actually eroded the value of investors by providing negative returns of 8.43 per cent CAGR in three years.[PAGE BREAK]

Another fact drawing our attention is Satyam Computers (now Mahindra Satyam). While the scrip witnessed turbulence in the short period after the fraud came to light, in the long term, its CAGR stands tall at 36.86 per cent.

Now all these factors only suggest that events hardly matter in the stock market. What drives the market in the long-term are the fundamentals and not the short-term events. Whatever the events, valuations catch up with fundamentals in the end. If you are a short-term investor, market fluctuations can have an impact on your returns, but if you are a long-term investor, these events don’t matter.