Thursday, January 21, 2010

Why did the Sensex fall so much today?

One of the favourite pastimes (or is it bread-and-butter?) of market analysts is to assign reasons for gyrations in the Sensex after it has gone through a big up or down move.

Some times the reasons are genuine and accurate. Mostly it is an exercise in trying to explain the unexplainable. The Finance Minister said that inflation in food prices will slow down, so the Sensex moved up. Several Indians are on a ship hijacked by Somali pirates, so the Sensex moved down. You get the drift.

I have no intention of doing a post-mortem. I'd rather quote from this recent article:

'... stock markets generally 'discount' good or bad news months in advance. If you own stocks that make up the Sensex (or Nifty) index, and if such stocks have risen a lot already and are now showing signs of hesitation - then they may fall if the results are perceived to be less than great. Only positive earnings surprises can cause them to rise more.'

Larsen and Toubro's Q3 Profit After Tax (PAT) grew 15% on a Year-on year (YoY) basis; the stock fell more than 6.6%. BHEL's Q3 PAT rose more than 35% on a YoY basis; the stock dropped 4.25%. Wipro's Q3 PAT increased more than 21% on a YoY basis; the stock dipped by 2.2%. ONGC's Q3 PAT was higher by 23%; the stock shaved off 2%.

Is the market behaving irrationally? Not at all. The results were below the market 'expectations'. It was the expectations that were irrational.

Will the Sensex fall some more? The probability is high, because the expectations of growth of the Indian economy has been on the irrational side as well. The actual growth is likely to be lower.

For the April to December '09 period, indirect tax collections have suffered. A 13% dip in excise duty, a 6% drop in service tax and a hefty 28% cut in customs duty has led to an overall 18% lower collection over the previous year's same period. These figures will not enthuse market players.

World indices are facing headwinds, with the Dow dropping like a stone at the time of writing this post. FIIs have been selling for some time, and buying by DIIs may not stem the rot.

What should small investors do? If you have been reading my blog posts regularly, you already know my answer. Wait and watch, but stay nimble. Curb the urge to dive in. This could be a quick, sharp cut before the Sensex recovers. The India growth story is far from over.


Eswar Santhosh said...

For sometime now, I have stopped listening to these "post-mortems". TV channels and business newspapers have to do it because it's their "job". Also, they are meant to be experts who should explain the poor retail investor who is clueless about the reason.

I am just an ordinary investor who likes prices low or high and do not bother when they are in between ;)

Of course, sometimes I too become part of the herd and do things that I should not have even thought about. I am just trying hard to reduce such instances as I go along.

I love my innumerable mistakes, however - as I now know what not to do. I still may repeat some of them as I am fallible and not completely rational. But, such slips will (hopefully) result in a much stronger resolve to avoid the emotional trap next time..... I guess I've digressed far from commenting on the blog post :)

Subhankar said...

You are a few steps ahead of most investors, Eswar. Most don't even know what mistakes they are making.

Greed and fear have strong psychological effects on the human mind. Learning to conquer both takes patience and discipline.

Mitran said...

Earnings estimators are too pessimistic at bottoms and too optimistic at tops, just when you most need the indicator to tell
the truth.” This is what we were getting at last month when we used highly optimistic earnings expectations as a contrary indicator. Earnings must now boom to fulfill expectations. As they fail to do so, stocks will tank, and people will say it’s because earnings disappointed. No, it’s because social mood turned down.

Jasi said...

Awesome observation!
People have been buying in hordes stretching the valuations. Ofcourse the earnings dint do their bit to support their fantasies, hence the correction.
Although I still feel that the markets just need an "excuse" to fall but ya over a longer time period, markets make perfect sense :)

Thanks once again Sir for an excellant post.