The mini-budget effect

BEATING THE STREET

One has previously noted the "Budget Effect" "" the stockmarket always travels down post-Budget. If it's a harsh (or silly) Budget, the market reacts down for fundamental reasons. If it's a benign Budget, the market reacts down because the market is full of optimists who want the sun, moon and stars.

On the rare occasions when the Budget is received favourably, some scam or political shindig shortcircuits bull-runs. In 1992, the unravelling of the Big Bull's ingenious methods of tapping the banking system halted the bull-run.

In 2000, it was the unravelling of Ketan Parikh's methods of ditto that led to a post-Budget crash. In 1999, the government lost a Vote of No Confidence. In 1996-97, two minority governments crashed in rapid succession.

Well, this year, we're seeing the Mini-Budget Effect! This pullback is partially due to fears arising about the plugging of the Participatory Note route. It's also due to excessive optimism. Instead of celebrating broad-ranging duty cuts and FDI sector-limit hikes, the market chose to express petulance about the deferral of hikes in FDI limits in telecom.

At first glance, the PN factor shouldn't have caused such a sell-off. In the past few sessions, the FIIs have been massive buyers, bringing in non-PN funds. But still the market has fallen because of massive domestic selling. Why should the blocking of that one route cause so much turmoil?

Is it that PNs are the preferred route for repatriation of hawala money? Unaccounted money is the lifeblood of an Indian general election. Political entities, who were relying on funding campaigns by repatriation through PNs, are now selling to raise cash via other means.

If one speculates in this fashion, we can have fun developing conspiracy theories on the following lines. One section of the political establishment "" the ruling government "" possesses assymetrical information about election timing.

That section also has the power to choke off PNs. Does it make sense for the government to quietly repatriate the funding required for its own purposes and then ban PNs to deny that route to rivals?

Putting aside conspiracy theories, the exuberance of early 2004 has now turned into a mood of manic-depressive gloom. The market is 15 per cent off its all-time highs after a sustained bull-run that drove it up 110 per cent in 9 months. This seems a fairly normal correction but investors are harking back to the dark days of 911!

Fact: Valuations are reasonable with indices trading at mid-teen PEs.
Fact: Indian bull runs usually last 12-18 months and end with index PEs of 35-40.
Fact: The revival has been broader than in living memory.
Fact: Infrastructure has improved to the point where it's almost acceptable leading to growth in trade and cuts in transport and communication costs.

Interest rates are low "" bond yields are dipping in and out of negative territory post-inflation-adjustment. If inflation creeps up a bit, we will have negative real rates. That's a classic confirmation signal of a cyclical economic revival since it guarantees investments.

Election equations could mean further dips in stockmarket values. But this seems like an great opportunity to make a long-term bet on equity. What else will offer higher returns?