Reality dawns

After gaining nearly 1,200 points from its low in three trading sessions till Monday, the markets saw some selling on Tuesday as the Sensex fell 175 points. While three good days is a very short time to confirm that the worst is over for Indian stock markets, but from total pessimism, the general opinion in the stock market has changed somewhat as the market came back to the near 10,000-point level. If the Sensex took 24 sessions to lose 3,872 points between May 11 and June 14, it has recovered over 1,000 points in the past four trading sessions, as foreign institutional investors pumped in Rs 821 crore between last Thursday and Monday.

As the dust from the market fall settles, things do look clearer. While there were several reasons doing the rounds, the only important reason turns out to be that investors have gone back to their spreadsheet and done a reality check.

FIIs did take a glum view on emerging markets in May, and there was not enough support from domestic buyers, though cash-rich mutual funds were investing. The fact that markets were perched at a new top only accentuated the fall. Between May 11 and 31, FIIs sold equities worth Rs 11,953 crore while mutual funds invested Rs 6,677 crore. But in June the story is exactly the opposite. This month till June 19, FIIs have brought in Rs 2,140 crore, while domestic funds have been net sellers to the tune of Rs 2,178 crore. Despite the FIIs turning positive this month, it did not stop the market from making a new low of 8,799 points on June 14.

While rising crude prices or the interest rate hikes by central banks worldwide are held responsible to some extent, these are not new events to change the sentiment so dramatically. Commodity prices, which have fallen worldwide, are likely to only benefit India Inc's overall numbers, as long as consumption continues. If the bulls were trapped, they would not have held on to their long positions much after May 22, when the stock exchanges closed for an hour after the index fell 10 per cent. While some investors would have booked profits once the markets started falling, there are good chances that bears came into action.

The bull market, which began in June 2003, has lasted three years. Besides this decline, the other sharp correction took place in May 2004, after the parliamentary election results. Enough ink and airtime have been spent to highlight that the India story had got slightly exaggerated as the market started falling from its all-time high of 12,671.11 points on May 11. But other factors such as GDP growth and consumer spending still remain strong for investors. So, it is unlikely that we are going to see investors turn bearish yet.

Corrections are considered healthy as they provide new investors reasons to invest and temper existing investors' expectations. With three days of a rise, there is no way to say whether this rise is a correction in a bearish market, or whether the worst is behind us. By conventional definitions, a bear market is signalled by a 20 per cent decline from the top that lasts for over two months. While we have seen a 30 per cent fall this time, it has barely been a month to call it a bear market. With the huge differences between the day's high and low, only a few traders can make money, and that too after taking huge risks. The myth that India, with its strong domestic economy, could withstand a global onslaught has been shattered. Ultimately, it is valuations that will drive investors. If a market turns expensive, both foreign and domestic investors are going to exit. The good thing after the fall is that it will be valuations, and not euphoria, which will drive investors. People have already started talking about P/E multiples, monsoons and the June 2006 quarter results.