The Hindu Business Line : Difficult recovery

A late afternoon correction in pivotal stocks notwithstanding, equity values in the market were battered for the second day running. This has, quite naturally, prompted fears that the market may be gripped by bearish sentiment that may take long to dissipate. It is ironic that, at a time when business confidence is still high — the economy is expected to post an 8.5 per cent growth in real terms — the market should be in a state of jitters. It would be temptin g to blame it all on the irrational credit exuberance in the US housing loan market, or what has now come to be described as the ‘sub-prime crisis’. Equally, it is easy to see the present crisis as stemming from a liquidity crunch in the secondary market, what with funds being sucked out of the system by a couple of high-profile primary market offerings. While these factors could have played their part, the problem goes much deeper than that.

The origins of the present crisis could perhaps be traced to the beginning of 2006, when investor exuberance put equity values at a multiple of near-term corporate earnings (P/E ratio) that were seen only during times of equity ‘bubble’. PE multiples for pivotal stocks at the BSE (Sensex) went up from 16 to 27 in two years from the close of 2005. No doubt, there is some room for market players to factor in a higher earnings growth than was assumed until then. But nothing could have justified a belief in a higher growth rate that would warrant a 50 per cent upward correction in the price earnings multiple. What sustained the illusion was perhaps the entry of foreign institutional investors in greater numbers than hitherto. But international capital has its expectations of returns from the Indian market and it would be folly for domestic investors to see in their actions a vindication of equity’s intrinsic worth. A sharp slide in valuation was simply waiting to happen.

The correction witnessed later in the day on Tuesday might seem to suggest that the worst may be over for the market. But that is far from the case. For the rally, such as it was, was confined to the top stocks. Two, trading, on the whole, through the day had been done at prices that were 12-13 per cent lower than the already depressed prices of the previous day. Lastly, though the PE multiples have come down somewhat, they are still way too high by any yardstick of business fundamentals.

The recovery is bound to encounter resistance in the days ahead. There is salvation only in the economy moving to an altogether higher plane. That spells greater corporate profits and superior valuation for stocks. For that to materialise, the policy constraints that act as hurdles to fresh investments in many sectors have to be removed. The ball would certainly seem to be in the Government’s court.

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