Parag Parikh: Where has rationality gone?

The stock markets are heated and the indices are rising. Last Monday, we saw a jump of over 400 points in the Bombay Stock Exchange’s (BSE’s) Sensitive Index, or Sensex, and 127 points in the Nifty. Next day, newspapers talked about the big bull market in the offing, and credited the rise to the latest Index of Industrial Production figures, robust increase in automobile sales and fresh inflows of foreign institutional investor (FII) money. So called experts, fund managers and analysts predicted the markets would keep rising, and the Sensex could even touch 25,000 in the near future.

Availability heuristic is at play. All available information on the economy and stock markets is positive. There is optimism everywhere, and investors are overconfident of their knowledge and abilities.

I did some number crunching and the revelations were startling. On the same Monday, declines outnumbered advances on BSE (1,498:1,492). If there was so much noise about the new bull run, why did we have a roughly 50:50 ratio of advances and declines?

Here is another glaring insight. For the 13 days ended September 13, the Nifty rose 5.26 per cent and the National Stock Exchange cash market volume rose by only 18 per cent, while the comparable volume in the derivatives segment rose a staggering 62 per cent.

Yes, India really stands apart from rest of the world when we measure the various economic indicators and the gross domestic product growth. But to conclude that these realities are reflected in the markets is a grave mistake. The stock markets still lack depth.

There was a time when the stock markets of a country were a barometer for its economic health. Unfortunately, in present times, the stock markets are more susceptible to greed and fear than earlier, and thanks to such financial innovations in the form of futures and options, we have unbridled speculation.

Prior to liberalisation, speculators were mostly individuals. Now, we have FIIs and mutual funds with deep pockets (other people’s money), and a vast array of financial derivative products at their disposal. The current volatility is the result of them playing heavily in the futures and options market. The above startling figures confirm the markets are controlled by punters and speculators in the guise of investors.

Why is it so easy to manipulate our markets? When we look at the markets, we look at the index movement. The Sensex and Nifty comprise 30 and 50 stocks, respectively. Is it appropriate to have such a small sample size to judge the markets’ health, when we have over 6,000 listed stocks? Moreover, bigger the market capitalisation, more is its weight in the index. So, it becomes very easy for speculators to dominate trading in both Sensex and Nifty, and control the markets.

So what does one do? I am in no way suggesting that one should sell all their stocks and sit on cash. Stocks are still the best investment opportunities today, as they are the best hedge against inflation. Ride your winners and sell your losers. Such bullish crazy times can continue for an extended period. Enjoy the bull run without participating in it. As it is, the stocks you already own are rising. Do not chase any fancy of the markets, especially overpriced initial public offerings.

The writer is chairman, Financial Advisory Services. Veiws expressed are his own.