The Mind Of The Market
When I K Gujral was appointed Prime Minister, the Sensex shot up by over 150 points. The markets were seen to have responded favo-urably and were happy with Mr Gujrals selection! The more accurate reason could be that with an election avoided, a period of uncertainty was getting over. The business community prefers stability, and the markets could have acted in line with normal business, leave aside economic logic. As such, there can be no quarrel with this.
But barely a fortnight before that, when the Congress withdrew support to the Deve Gowda government and the country was facing another bout of uncertainty, the stock markets surged by over 100 points the next day. Nobody said that markets were happy to get rid of Deve Gowda, which would have been acceptable to me, as it would be pretty close to a normal human reaction. Instead, a whole complicated logic of discounting was applied. It was analysed and decided that the market had come to terms with the political convulsions that the country was going through. To top it all, this empirically unverifiable and hence unassailable logic of the rationality of the markets recourse was linked to economic fundamentals, which the market perceived as remaining strong in spite of political uncertainty, and which this all-knowing entity had discounted within a day.
The day after the Congress withdrew support to the Gujral government, the markets surged. Not to be outdone, market enthusiasts said that this was due to a phenomenon called smooth pasting: the market doesnt react to a development which has been in the offing for quite some time. It is a subtler version of discounting.
Having assumed that the markets know all, it is only logical to draw inferences about macroeconomic behaviour from the movements of the stock market. It is presumed that stock markets are leading indicators of the economy which send signals regarding investment decisions. As a result, they portend what is to come in the real economy. This generalisation is made notwithstanding the fact that in the past, indicators like the Sensex have not borne any meaningful relation with movements in the economy.
The errors get compounded by the undue attention being given to the secondary market. Even if the stock markets are seen as an important source of finance which affect economic activity, can anything worthwhile be inferred from trading on the secondary market? While it is true that trading in the secondary market guides the future flow of investible funds through the primary market, the fact remains that when shares change hands on the secondary market, resources do not directly go into investment. The simple point is that in all the obsessive concern for trading in the secondary market, the behaviour of the primary market, which is relatively more important, goes largely unnoticed. While the hiccups in the Sensex are commented upon in detail, the convulsions and crisis in the primary market go unnoticed.
Though there may be disputes about how much the markets know about all major developments, there is little doubt that they react almost every time such developments take place. But when it comes to explaining the reasons for price movements of individual scrips and companies, they tie themselves up in all kinds of knots. Thus, for example, in the last two days, one got neither a satisfactory nor an esoteric explanation of why the Indo Rama scrip was behaving the way it was. Or why the ITC scrip took such a hammering when its board meeting that day had nothing significant to offer? The markets do seem to know everything, except their own mind.