The worst ever fall and after

22 January 2008

Just when it appeared as if there was never a better time for Indian equities, markets suddenly crashed. What caused the fall and where do we go from here? By Vivek Sharma

At the beginning of this month, there was hardly an analyst who forecast a deep market correction. The most pessimistic expected mild bouts of profit booking, nothing worse. The majority were confident that good times would continue. Here are a few samples:

• "Very few other markets offer a combination of strong economic growth, stable macro economic environment, good corporate performance, favourable demographics, rising domestic participation and good resilience to US economic slow down in 2008. Concerns over valuations may ease as Indian markets could get re-rated later in 2008" - DSP Merrill Lynch
  
• "We believe markets will be consolidating in FY09. We will be seeing multiple peaks during the year and would likely to trade between 25,500 and 18,000. Our belief is Indian market is largely insulated from the US market" - Religare
  
• "All factors look positive for the market at this point and the market is poised for an upswing" - Angel Broking
  
• "India is no longer a potential market but one that is already living up to its significant potential. Strong third quarter results from Indian companies will further encourage FII buying, especially from those yet to enter India"" - Religare again
  
• "An investment boom, in our opinion, could unlock their full potential. India can soon achieve 10 growth rate" - Lehman Brothers

These statements and analyses reflected the mood that prevailed, when voices to the contrary were being dismissed as being overly pessimistic. To be fair to the institutions quoted above, it was too difficult to take a call against the unprecedented momentum witnessed in the past few months. Fund inflows into the market during the second half of last year were way beyond even the wildest forecasts. Expectations were that fund flows would continue unabated, and could even rise further in 2008 as sovereign funds too joined the quest for profits from the India story.

After all, Indian corporate earnings growth, even if there was a modest decline from last year's levels, was forecast to be substantially better than in other Asian countries. Indian companies were making large investments in capacity addition and expanding overseas through acquisitions. The policy climate remained favourable, with hopes of a modest decline in interest rates. The government was expected to support industrial investments and consumer spending through populist policies, ahead of elections due next year.

Then there was the IPO mania, fuelled by spectacular dreams of future growth potential and nothing concrete on the ground - as in the case of Reliance Power. The extremely aggressive valuation of this IPO led to a dramatic increase in the valuations of other stocks in the sector.

Oil refining stocks tripled and quadrupled in a matter of months on hopes of ever increasing refining margins, even though some of these refineries are yet to go on stream. High product prices drove metal stocks while banking stocks surged on the 'great India opportunity' story and hopes of the sector being opened up for foreign investment by next year. Only technology stocks lagged, as the strong rupee and rising costs ate into margins.

Then there was the great 'decoupling' theory. The proponents of this theory were confident that emerging economies like China and India have cut off their umbilical cords from the global environment and can grow even if the rest of the world sinks into a mess.