Nasdaq is the latest fashion

D. Sampathkumar

Indians have had no difficulty in believing that distant planets cast an influence on their lives.

The immense popularity of features on astrology in newspapers and magazines is a testimony to this phenomenon. In the circumstances, it should hardly occasion any surprise that native punters in the stock market should concede for the market a capacity to be influenced by movements at the Nasdaq or, for that matter, the New York Stock Exchange.

Yet, until very recently, Nasdaq seemed an abstraction to most market-players in the country. The earliest reference to price-trends in Nasdaq, as far as this writer could recall, was only a year-and-a-half ago. A news report then referred to a phenomenon of `foreign' fund managers using the Nasdaq composite index of stock prices as a benchmark for exposure to information technology stocks in the country. They would increase their exposure in the Indian IT stocks if the Nasdaq was seen as bullish and reduce their exposure if the near-term outlook was perceived as bearish.

A perception that domestic price movements are linked to that of similar movements at the Nasdaq came to be strengthened only after Infosys Technologies got its American Depository Shares listed there, a year ago. Analysts talked of price movements at the Nasdaq and, more specifically, the price at which Infosys ADS came to be traded in that exchange which was dutifully reported in the press.

At one level, the link with the American stock market may seem rather tenuous at best. After all, profits of domestic Indian companies may have nothing to do with American investor perceptions about `dotcom' company stocks which drive the Nasdaq market. Moreover, companies in the manufacturing sector, which account for a substantial chunk of value, may not be directly affected by any downturn in US infotech stocks. For most companies, their exposure to the US market itself is at best meagre. They, after all, cater mainly to the domestic market. Even otherwise, they would have no reason to worry about a decline in the US market, unless such a decline leads to a general recession in that country's economy.

It matters little whether or not there, indeed, exists a link between the two markets that is conceptually valid and internally consistent or not. There is no doubt that investors are going to follow future movements in the American market with an avidity, far in excess of what may be justified in the context of global integration of economies. For instance, investors in the shares of Infosys at these two market, may well be insulated from one another. But that is still not going to prevent them from taking positions in the Indian market, based on expectations of price movements in the ADS of the company.

This should occasion no surprise. Investors are not taking reasoned judgments on the underlying value of shares. They are merely taking speculative positions, based on what they think the shares are worth, but rather what they believe that the market would value them tomorrow. It is clear that such speculative pressures are at work, if one looks at the factor by which unit of shareholder earnings are multiplied to arrive at an unit value of shares. Thus, a rupee of profits of Zee Telefilms not too long ago was valued at nearly 800 times. By a conservative estimate, such valuation would require that the company's cash profits practically treble every year which seems absurd. If it is not driven by any fundamental considerations of value, it follows that the current valuation is driven solely by speculative expectations of growth in share price in the future.

When investors are driven purely by speculative profit motives, their operations can be likened to a game played according to a set of rules. In this game, the rules could be anything as long as each investor believes that the community of investors, as a whole, plays the game by that rule. They may not believe that the number of buffaloes on the streets of Chennai has anything to do with the share price movements. But fiscal deficit, political instability and now, of course, Nasdaq movements are fair game.

Funnily enough, a joke that used to do the rounds at the IIM campus in Ahmedabad years ago, had it that the stock price movements are linked to the number of buffaloes on the streets of Ahmedabad. The reasoning behind that is simply this: Buffaloes come out on the streets when it starts to rain. Rains, of course, are good for the crops. A bountiful harvest pushes up rural incomes and demand for all manner of goods and services and that should paint the corporate bottomlines with a thick coat of black.

Buffaloes on the streets of Ahmedabad are, of course, a more sober version of the more celebrated off-colour connection between rising hemlines of skirts and stock prices. The rising hemline is linked to higher corporate profits through a complex network of causal relationships starting from fashion consciousness among women to higher disposable incomes and through that to corporate profits.

The root cause of the problem, therefore, lies in a phenomenon of values being unrelated to business fundamentals. For, if the values were inherently related to business fundamentals, investors would not have to worry about anything else. They can just buy the stocks and wait for the price to catch up with a long-term track record of financial performance. It is because the investor is influenced by considerations that have nothing to do with future earnings that he is a prey to short-term considerations.

In other words, it is a game that is played for the short-term where the winner is spotted for the ability to second guess the market. The moment the game has been reduced for him, to one of second guessing the market movement in the future, he is going to play the game by an elaborate set of rules. Of even greater importance, the rules are going to be modified constantly with some of the old ones being discarded and new ones introduced.

The point simply is this: Markets have traditionally relied on causal relationships and the composition of price impacting causes are like fashions changing over time. The Nasdaq performance is only latest in the series of events by which markets have set store by, all along.