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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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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posted by Pitabas Mohanty at 7:38 AM
2 Comments:
True, but not at this level. Corrections do take place even in an efficient market. However, if prices increase everyday and keep increasing for years, then there is something wrong.
It has nothing to do with information efficiency. It is operational inefficiency. Some people are manipulating.
is the reasoning not akin to saying that unless there is no new information/news about a company its stock price should not change i.e. after adjustment for overall market movements for the day ? Even if there are timelags as pointed by arvind in a semi efficient market, after a few days required for assimilation of the new information by the market, price should more or less remain static(after accounting for changes explainable on the basis of beta). But this is not what we generally observe. I guess this is becoz markets are driven more by sentiments (possibly irrational exuberance) than sound fundamental analysis. Possibly reliance of some investors(even big ones) on technical analysis makes them still see some upside to already high prices. I am just speculating here like most investors in the market :-)
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