A 'black swan' event

The stock market carnage has reached proportions that may have no recent precedent "" a stock market drop of more than 20 per cent in no more than seven trading days is what might be called a 'black swan' event, a one-off episode that may have caused many heart attacks, literally and metaphorically. But other than the stoppage of trading for an hour on the Bombay Stock Exchange, there has been no market failure so far in terms of defaults, though there are plenty of rumours about payment difficulties between brokers and clients. While there could be debate about the impact of single-stock futures in fairly illiquid stock which therefore have suffered the most, and the way margins operated to trigger fresh selling "" both of which have probably caused a sharper fall than might otherwise have taken place "" the fact also is that some of those elements were what drove up the market in the first place. The people who have paid the price are therefore likely to be those who adopted risky trading strategies in a risky market. The finance minister's advice to investors "" to take informed decisions calmly "" could and should have been offered at the height of the bull run too.

Looking forward, the immediate questions are whether the market has bottomed out and how the crash should be understood. Since the drop in Indian share prices has been broadly in line with a global drop in share prices, and given the growing concerns about the US economy, some of the answers lie outside India. Indian shares continue to be more expensive than stocks in other emerging markets. So, it is possible that there may be a little more of a drop. Even if that were to materialise, it is important to remember that most share prices are still significantly higher than they were a year ago, and so, the last 10 days are likely to be seen as having witnessed a correction, and not as the start of a bear market. There may or may not be a smart recovery from here, but value investors will find no shortage of good stock to buy at reasonable earning multiples.

What broader impact will the market crash have? One possible consequence could be a drying up of public share offerings, which in itself may not be a bad thing because it is clear that many companies were planning to come to the market not because they needed the money so much as to take advantage of an overheated market. Companies that need to finance projects and capital expenditure will probably continue to consider IPOs because valuations are not bad by any yardstick other than those used in the last four months. The part disappearance of the 'wealth effect' could have its impact on non-essential consumption, especially in the 'mass luxury' market, but the bigger impact is likely to be on other asset classes "" like real estate and gold. This too may be welcome because residential and commercial space prices have been in the stratosphere for some months. In any case, all of these put together are likely to have less of an impact on the real economy than a rise in interest rates or the slowdown in exports caused by the rising rupee and the US slowdown. The real worry is whether the financial crisis in the US will get bigger, and if so by how much. A full-blown crisis there could upset many parties.