Wednesday, January 23, 2008


The news is full of people holding their heads in despair as they stand outside the Bombay Stock Exchange gazing at the plummetting Sensex; of Rs 18 lakh crore being wiped out in two days; of Gujaratis going bankrupt; of angry investors demanding the Finance Minister's resignation.

All because the markets all over the world reacted to jitters about the health of the US economy, and Indian investors followed suit. The huge selloff that resulted sent the sensex down to levels it hadn't seen since, well, four months ago. If you invested before September 2007, and have a reasonably diversified portfolio, you're probably ahead of the game.

Or suppose you did lose some money. Suppose you invested when the market peaked, earlier in January, and lost about 20% of your investment. How long would it take before you got it back? Nobody can predict, but we can look at the past. If your portfolio performed similarly to the Sensex, and you had invested at the peak in May 2007 and rapidly lost about 25%, you'd have gained it back by about October 2007; and today your investments would have appreciated another 40% or so, after the crash. If you had invested at an earlier peak, in January 2004, you'd have lost about 20% when the UPA took office in May 2004; you'd have gained it back by November 2004, and gained about 200% in a little over 3 years since then (again, after the present "meltdown").

So even if you put your life savings in a reasonably diversified portfolio, you probably haven't lost more than about 20%, and can reasonably hope to gain it back in months. Yet rediff reports that many "small investors" (not day traders) have "gone bankrupt". Who are these people and how did they manage to go bankrupt? The article quotes an investor who bought Reliance Petroleum at Rs 270 and is lamenting the sight of people selling it at Rs 130. (It's silly to put all your eggs in one basket, but this particular basket is likely to be around for the long term.) But why would he want to sell, and even if he wants to and gets half the price he paid, why does that make him bankrupt? I can only imagine one scenario: he (and the other small investors) borrowed heavily to invest in the stock market, at exorbitant interest rates that they hoped the Sensex would outstrip, and now their creditors are calling.

But of course the past doesn't predict the future. How do we know the markets will recover? I think there are two points of view: if you think the fundamentals of the Indian economy are sound and growth will continue regardless of what happens in other countries, and most importantly if you believe that stock valuations today reflect the actual market worth of companies, you should stay invested. If you think the US economy will imminently go down the toilet and take the rest of the world with it, or if you think Indian stocks are overvalued, you should dump your stock now and invest in safer vehicles. But in that case why did you wait for the crash? People have been talking about the shaky US economy for a year or more, about overvalued Indian stocks for even longer, and the US subprime crisis hit many months ago. (Of course, if you had dumped the day the subprime crisis hit, you'd regret not having stayed invested until today.)

One last thing. Suppose you really believe that there are serious concerns about the health of the US economy, and that it will affect the rest of us. Why would Mr Bernanke's interest rate cut reassure you? Is there anyone in the world who thinks it will actually prevent a crash, as opposed to delaying it (and making it bigger when it comes)? Who are all these people who sent the markets rebounding today (and is it a safe prediction that they will panic again tomorrow, on seeing the jitters today in Europe and the US?


km said...

Warren Buffet once boasted at a shareholders' meeting that his investment managers were happy sitting around twiddling their thumbs while the rest of Wall Street traded. Paraphrased obviously, but I love his sensible attitude.

Why the stock market "crash" is news is beyond my comprehension. It's a stock market - prices will go up and down. After all, when markets go up 200-300 points, we don't hear of suicidal investors changing their minds about popping themselves....

BTW, have you read Nicholas Taleb?

Rahul Siddharthan said...

Nope, hadn't heard of him. Just looked him up and he sounds interesting. What's your take on him?

km said...

Rahul: He has a contrarian view about Wall Street, which makes him quite provocative naturally. His book "Fooled By Randomness" is worth a read. (I've not read his more recent bestseller, "The Black Swan")

Anyway, the central premise of his thesis is that Wall Street vastly over-estimates its technical abilities and fails to recognize randomness as a key factor in its success.

Tabula Rasa said...

i haven't read the books but have a passing familiarity with them. i have them down as prospective plane / social visit reading. rahul, they're not very profound but i think you'll probably like them anyway.

Anonymous said...

Buffett has also said "Be fearful when others are greedy and greedy when others are fearful". The markets have been greedy for a few years now. It's their turn to be fearful now.