Anatomy of the Market Movement

In the last three-odd years, the stock market has registered phenomenal growth in India. Analysts (that today includes anybody and everybody) generally extend two arguments for this growth:
a) There are fundmanetal factors responsible for this growth. The GNP is expected to grow at 7 to 8 percent and Indian economy is booming, etc. The list goes on.
b) There are liquidity factors responsible for this. FIIs are pumping money into India and hence the prices are rising.

Which one of these factors is responsible for the market growth? Both? Neither?

I think neither. Let's see.

I studied the stock market behavior in the last 30 months (of 2783 stocks) to find out:

a) Whether the fundamentals are really that strong to warrant this growth in price
b) Whether we can link FII stake in the company with the stock returns?
c) Whether we can link institutional investors' stake in general with stock returns?

I am presenting the key results here:

1. The growth in stock prices is a market-wide phenomenon and is not restricted to any particular size. The large cap stocks have registered an annualized growth rate of 50% in the last 30 months. The mid cap stocks and the small cap stocks have registered 134% and 175% growth in the same time period. To put things in perspective, Nifty registered an annaluzied growth of 62% in the same time period. If anything, the large cap stocks have registered much lower growth as compared to the relatively smaller stocks. (Size effect :))Many analysts would be happy to see these results because they are arguing that what we see is not a scam, and that price increase is not restricted to handful of stocks and that the entire market is bullish. Even I thought so, when I saw the results.
2. The median FII stake in the large cap stocks is 4% (as against 19.33% in Nifty). It is zero for the mid-cap and small-cap stocks. What does that mean? The FII investment is restricted largely to the large cap stocks. So FII investment cannot explain the huge growth we have seen for the mid-cap and the small-cap stocks.
3. May be it is the mutual funds, banks, insurance companies and other financial institutions that have invested in the mid-cap and the small-cap stocks. Let's call them OFIs (Other Financial Institutions). The OFI investment in the large-cap stocks is about 5% (against 11.6% in Nifty). The median OFI investment in mid-cap stocks is 0.01% and 0% for the small-cap stocks. The financial institutions have invested mostly in the large-cap stocks. This means the market rise is not liquidity-driven. May be liquidity increases the price to some extent. That is without FII and OFI investment, may be the returns to the large cap stocks would have been little lower. But it would have been very high nonetheless.
4. What about the fundamental story? I love the DCF story. Let's look at dividend per share. The median yield for the mid-cap and small-cap stocks is 0 percent again!!!! That is, the market has increased the prices of a group of stocks by more than 150% who have not paid any dividends. The dividend yield is a mere 0.9% for the large-cap stocks. Even here, one needs to be really mad to justify this price. To see this, the median market cap of the large-cap companies in my sample is Rs.4381 crores. With a 1% dividend yield, the expected dividend on this is Rs.43.81 crores. This reminds one of the famous Saint Petersburg Paradox.

So who do you think moves this market?

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New Way of Ranking Business Schools

Ranking of Business schools has always created its own share of controversy because people always disagree on the methodology adopted. Some give more importance to industry interface and others give more importance to faculty research.

Social Science Research Network (SSRN) started a new service whereby it ranks the top business schools by the research papers downloads from the website. Undoubtedly, it has the most comprehensive library of research papers available in the field of social science today. The logic is simple. If a B-school has good faculties with good quality research papers, then more and more people will download those papers. It leaves the final decision to the market.

In SSRN.com, one can first read the abstract of the paper and then decide whether to download the paper or not. So it seems to be a good way to rate the business schools. To see the complete list, visit
http://hq.ssrn.com/rankings/Ranking_Display.cfm?TMY_gID=2&TRN_gID=11

To view the rankings of the international business schools, visit

To view the full list of International Business Schools go to:
http://hq.ssrn.com/rankings/Ranking_Display.cfm?TMY_gID=2&TRN_gID=12







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Poor Monsoon Predicted for India

After nine years, the weatherman finally predicted a poor monsoon in India for the year 2006.
With services sector dominating the Indian economy, this may not have any significant impact on Indian economy. My research shows that Nifty generated a return of 21.55% when Monsoon was normal in India. It generated a mere 10.89% return when monsoon was below normal. This is based on the performance of Nifty during the sample period 1991-2005.

One can argue that these results are biased because the services sector started dominating Indian economy in the latter part of the 1990s. Hence, a poor monsoon is unlikely to affect our stock market much.

I however, believe that if the market values stocks sensibly (a big If in India), then a poor monsoon will adversely affect the Indian economy and the stock market.

A poor monsoon is definitely going to affect the agricultural sector and some of the manufacturing sector that is going dependent on agriculture. A substantial number of the consumers of the FMCG sector, for example, are farmers. And this is going to affect this sector.

Secondly, the subsidies that the GoI is going to the farmers will also increase in the next year. Since the farmers in India are politically powerful, they may also demand for things like loan waiver, etc. We have seen all that in the past. This will have an adverse impact on the fiscal deficit in India and that will also affect all the sectors in India.

However, its impact will not be as powerful as it used to be in the earlier decades.



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Book on Investments

The book on Investments written by Bodie, Kane, and Marcus, undoubtedly is the best book on Investment written till date. Last year I got an opportunity to edit the book for the Indian audience. The idea is to include Indian examples, include discussion about Indian market mircrostructure issues, include discussion on Indian regulatory environment, etc.

And the Indian edition is out now. Hopefully, the Indian audience will find the book still more useful and interesting.



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Who Moves the Market?

Every Tom, Dick, and Harry says that the market is overvalued. Do not buy. A random selection of a few equity research reports available online shows that all the analysts are bearish on the market.

But the market rises almost every day (with minor exceptions like what happened this Friday). The prices of most of the stocks (I can venture to say all...) do not make any sense at all.

Consider this. You assume that dividends will grow at 30% pa for the next ten years. Assume a terminal growth rate of 8%. Assume a discount rate of only 10%. Keep in mind that all these are highly liberal forecasts. You get a value (for nifty) that will come closer to the current market prices. So if you believe the current prices are still going to incresae, then you are more optimistic that what the above numbers indicate.

The discount rate will probably come closer to 17% for an average stock given the high rf and the normal market risk premium. (Incidentally, Prof. Rajnish Mehra (the equity premium fame) has estimated the market risk premium to be about 9.7%. for India. He has used 13 years of data to estimate this figure. The previous studies in India have estimated this figure at about 10 to 11%.)

Though the finance minister is talking about 7-8% growth for India, I am sure even he will agree that a terminal growth rate of 8% for the market is something, highly unachievable.

I did an event-type of study of SBI's price behavior this week to see if this market is rational. On Friday, the employees' strike ended the fifth day. The employees' union rejected the plea of the Finance Minister to call off the strike. A NDTV report shows that finance ministry is thinking of dealing with another nationalised bank in place of SBI. Most of the retail customers are unhappy and are thinking likewise.

And how did the market react? It (SBI stock price) reported an excess return of 0.9% per day (after adjusting for market and industry price movements). This is an adjusted return and should npt be confused with the actual return. On Friday, the stock price of SBI fell. But so did that of Nifty and Sensex and all the banking stocks.

A few months back, there was fire in ONGC. What happened the next day? Ofcourse, the price increased. The list goes on. There is no sense in this market.

Some of the brokers are saying this is not a scam for two reasons:
a) the increase is broadbased (that is you do not find mad prices for a few stocks, you find in all of them :)
b) the fundamentals are strong.

No body denies that the fundamentals are strong. Even a 20% increase for 10 years will be good news for many industries. The point is the market has already discounted the good fundaments long long back. To take a simple example, assume that the market has valued a constant dividend paying stock at Rs.50 (Rs.5 dividend and 10% discount rate). If suddenly, the fortunes of the company change and the market believes that the new dividend is Rs.10, then the price will increase to Rs.100 instantaneously. What is happening is that it increased to Rs.100 the next day and is increasing everyday after that and is now quoting at Rs.1000 and people still srgue that "Look! Its dividend has doubled."

It is not about fundaments. It is about another scam. Right now the issue is not what is the current value of nifty or sensex. The question now is who moves this market?

It is SEBI's job to do the investigate the price movements. Unfortunately, in India the regulators do not worry much when the prices increase. They think the market is happy with the economic policies of the Government. If the market is happy, then in an efficient market, the entire price movement will be felt in a single day. Not every day for a period of 3 years. In fact recently, when Sensex fell, Mr. Chidambaram made a statement that there is nothing to worry. It is just profit booking. He does not apparently bother when prices increase every day.








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