What's really happening in the equity markets
There are too many explanations for why the equity markets are in the doldrums, and not all of them make sense
By Dhirendra Kumar | Aug 16, 2019
It's now conventional wisdom that the general decline in the stock markets are due to a set of diverse and mostly unrelated reasons that have combined in an unfortunate manner. Since one should always be (very) sceptical of conventional wisdom, investors must examine it critically before accepting it and possibly acting upon it.
The first set of reasons are external and arise mostly from the trade war between the US and China - markets around the world are in a bad situation because of reasons that arise from the trade war. The unrest in Hong Kong - and the fear of a Tiananmen kind of event in Hong Kong, with unpredictable consequences - is also increasingly mentioned by analysts and the financial media.
The second set of reasons are essentially taxation issues related to the Indian equity markets, essentially capital gains tax as well as the FPI issue. The frequently and loudly expressed view is that investors are running away from investing and pulling out their money because the taxation on the money they earn in the Indian markets is too high for their liking.
The third set of reasons are the poor growth and profitability numbers that Indian corporates are generating. There's bad business news wherever one looks. The auto industry is going through what is beginning to look like its deepest and longest recession ever. The pharma industry has a seperate set of problems arising from its propensity to fake quality and purity, which is a character flaw that could be harder to fix than any mere economic downturn. The telecom industry could be looking at fundamental problems of what it costs to provide such services at scale and what a large mass of Indians can actually pay for. Banks, the less said the better. NBFCs, we all know the story. And so on and so forth.
Of course, there have been such phases earlier. I remember having a chat with a group of top equity fund managers back in 2003, and the general consensus, even in a group of professional optimists, was that it was hard to see why the stock markets would start rising. And yet, even as we were having this conversation, the greatest long-term secular bull run in the history of Indian markets had already begun. We just weren't mentally ready to recognise what was happening. I'm not actually saying that this is happening at this point, but then again, who knows. At that time, with hindsight, our biases got completely reversed. Within a year or so, we all started wondering how anyone could possibly have been foolish enough to have missed the impending bull run!
Coming back to conventional wisdom on the market decline, I find that only this third set of reasons has any validity. When the economy turns around (and I say 'when', not 'if'), and corporate profits and growth comes back, then the stock markets will also turn around. The tradewars and the taxation will not matter. I'm not saying that some of the tax changes are not unfair, but fingering them as the fundamental reason for weak markets is completely misguided. The tax issue has no substantial or sustained role to play in the fate of Indian equity markets, only the state of the Indian economy and the growth of Indian businesses does.
Earlier this year, in his annual letter to shareholders, Warren Buffett said that a large part of his success in life could be attributed to what he called 'The American Tailwind.' For decades, the fundamental reason that he made money was that the American economy grew, the rest was detail. That's an interesting idea. Can you feel an Indian tailwind? When you can feel it, then equity investments will start booming, the rest is detail.
One of my beliefs that have gotten reinforced is that crises are good in many, many ways. People, businesses, as well as ideas get tested, and it gets found out what they're really worth and whether they're any good at all. That's what happened at that time in 2001-2003, and that's what is happening now.