Why should we welcome market crash?
Economics assumes that human beings are rational. But human reactions to stock market movements are utterly irrational. When markets rise, everybody cheers. When markets crash — as has been the case for two weeks — everybody moans.
A hunt for culprits often ensues. No such hunt is ever announced when the markets are rising. In past scams, when manipulators like Harshad Mehta and Ketan Parekh sent share prices through the roof, they were hailed as geniuses and became celebrities. Some market experts cautioned that the markets had shot up to insane levels. But this plea for sanity was widely dismissed as stupid, and ordinary housewives and college kids bought frenziedly in the belief that share prices could only go up.
However, when the markets inevitably fell, the hero-manipulators were suddenly denounced as villains. They were accused of the dreadful sin of rigging markets, and thus misleading small investors. Ironically, no investor complained as long as the manipulators rigged prices upward.
The complaints began only when the manipulators were unable to rig markets any more, and prices crashed. Truth be told, the real public complaint against Harshad Mehta and Ketan Parekh was not that they manipulated prices upward, but that they failed to manipulate it upward forever. For that, this could not be forgiven.
The underlying assumption of small investors is that share prices should rise forever. Now, if the price of rice, sugar or petrol rose forever, the small investor would complain bitterly. Yet he seems to think it perfectly fair that share prices should go up forever, and very unfair if share prices crash. How greedy and hypocritical humans are!
Consider the current moaning over the stock market crash. The fall of the sensex from 12,624 to 10,400 represents a sharp 20% decline within two weeks. But few people seem to remember that sensex was at just 9,390 at the start of 2006. So, even after the crash last Monday, the sensex was still up 10.5% since the start of the year. No bonds or fixed deposits could give such a high return within five months. This point escapes the CPI(M), which sees the market crash as reason enough to stop pension funds from investing in equities.
Remember that the sensex was around 5,000 during the last general election in 2004. It then slumped to 4,282 on panic selling. From that low point, the sensex tripled in two years to 12,624 on May 10, 2006. That has been a bonanza, fuelling speculative frenzy. So, the 20% correction is to be welcomed. Stock market valuations remained stretched by historical standards, though not by developed market standards. If the sensex falls all the way to the 9.390 level at the start of the year, the market would still have yielded enormous gains to investors since 2004.
The long run prospects of the economy are excellent. So, some investor exuberance is understandable. Yet such exuberance needs to be tempered by sharp corrections from time to time. This sends the valuable message that exuberance is no substitute for judgement.
Human beings quote many aphorisms that they seem to forget when they enter the stock market. All that glitters is not gold. Don’t be penny-wise and pound-foolish. Look before you leap. There is no such thing as a free lunch. Better safe than sorry. A fool and his money are soon parted.
All who invest in markets must remember these aphorisms. Risk and reward go together. If there were no risk, there would be no market reward. Share prices represent subjective judgements of the day, so bouts of euphoria and depression will necessarily drive share prices up and down.
Marxists find this terrible. They deplore “casino capitalism”, and lambaste foreign institutional investors (FIIs). Marxists cannot bear to acknowledge that FII pressure has sparked capital market reforms that have made Indian markets among the best in the developing world, far ahead of China or South Korea. FIIs were earlier reluctant to invest in a market where one-tenth of all paper share certificates were forged, settlements were delayed for months on end, and thin turnover facilitated rigging by big brokers (and by companies before every public issue).
But after capital market reforms, FIIs have flooded in. They have invested in all emerging markets, but disproportionately more in India. They have favoured companies with good governance and transparent accounting, rewarding these traits for the first time (earlier, the ability to rig markets was rewarded most). Stock market reforms and FII inflows have hugely improved the ability of Indian companies to raise equity finance for expansion. This has reduced their dependence on debt, thus reducing interest rates as well as over-leveraged balance sheets.
The CPI(M) can see none of this. It believes only that foreign devils are making millions and paying no tax. So it demands a capital gains tax and an end to the Mauritius treaty that has been used as a tax loophole by FIIs. The CPI(M) seems unaware that Mr P Chidambaram is in fact taxing dividends and capital gains in ways that have made the Mauritius loophole irrelevant, and so ensured that FIIs are indeed taxed.
Dividend tax is now paid by companies rather than recipients; so FIIs cannot avoid it. A transactions turnover tax is being collected in lieu of capital gains tax. This brings all investors including FIIs into the tax net, and the Mauritius route has been rendered irrelevant. Domestic crooks used to avoid capital gains tax through benami small accounts, but now cannot escape the transactions tax. Thus Mr Chidambaram has ended tax avoidance and evasion, brought FIIs and Indian crooks into the tax net indirectly, and created a level tax playing field between domestic and foreign investors. That is a considerable achievement.
So, our problem today is not untaxed FIIs. It is the notion that markets should rise forever. They will not, and should not. We need sharp dips, not Marxist controls, to remind investors from time to time that stock markets have risks as well as rewards.
BullRider – Indian Stock Market Tips
Source by BullRider