The struggle between Newton's law of gravity and global markets is perennial. Many times it appears that the markets are defying the laws of gravity and breaking out of their orbit. However, in the end, it is the law of gravity that has always won. Notwithstanding the distance covered away from the “fair value zone”, and the time spent in the away zone, the asset prices invariably tend to return to the fair value zone. In the common market parlance these digressions and eventual return to normalcy is described by the phrases like Overbought, Oversold, Overvaluation, Undervaluation, Mean Reversion, etc.
It is important to note
that a long time spent away from the fair value zone could be very deceptive
for investors. Sometimes it gives an illusion that the fair value zone for the
subject asset may have already shifted higher or lower and the current price is
actually closer to the fair value zone. The investors lacking in discipline
and/or conviction may fall for this deception and buy/sell the asset in the
“away zone”. Two classic examples of this phenomenon are the stock price of ITC
Limited and IRCTC Limited during 2019-2021.
In the past one year, all
asset prices that were trying to defy gravity, without having necessary escape
velocity, are crashing back to their respective ground positions. Now since the
asset prices are correcting downward, trampling the traders and investors
coming in their way, the questions to ponder are:
(a) When would the asset prices hit the rock;
(b) Whether the rock will be soft or a hard one;
meaning whether the prices will jump higher immediately after hitting the rock
or they will get stuck there at the bottom, till the next high tide comes to
their rescue;
(c) Which assets are fragile enough to crash and
get destroyed when these hit the rock;
(d) Which assets are flexible enough not to get
damaged by hitting the rock and bounce back faster.
History could be a good
guide in analyzing these points and finding appropriate answers. However,
2008-2009 may not be a good reference point in this context, in my view. The
crisis began to hurt global asset prices from early 2008 as the economic
growth, fuelled by a decade of exceptionally loose credit, started to fizzle
out and financial leverage became unsustainable.
The process of adjustment
and correction was interrupted by innovative and audacious monetary policies of
large central bankers. Surprised and enthused by the "whatever it
takes" approach of central bankers, traders and investors made large bets
on a faster economic revival. Consequently, many asset prices in fact scaled
higher peaks than seen during the bull market of 2005-2007.
As it turned out that the
comfort was false. The central bankers did manage to restore stability in the
financial system; but the economic recovery remained feeble and unbalanced. The
global lockdown in the wake of Covid pandemic has completely exposed the fault
lines of the global economy and markets. Consequently, the asset prices are now
rationalizing to factor in the prospects of even slower economic recovery and further
rise in global imbalances.
The process is expected to
be protracted and painful. Nothing will be achieved in a year or two.
The good news, in my view,
is that India is decoupling from the global pain, as the painful economic
corrections implemented in the post global financial crisis era are now
beginning to yield results. In fact, as one of the worst sufferers of unfavourable
terms of trade, India could be a major gainer as the global imbalances get
adjusted to more fair terms of trade.
I am certainly not expecting any exceptional return from the Indian equities over the next couple of years. However, it is apparent that Indian equities can give normal returns for a much longer period than their peers.
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