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Stock market: Has it bottomed out?

R.Srinivasan

FOR several months now, when the values of most of the stocks on the exchanges have been declining steadily, our fund managers, analysts and investment advisors have been advising retail investors that the markets have bottomed out and that this is the best time to enter the markets for bargain hunting. When making an assessment of the status of our market which is now almost fully integrated with the rest of the world, the effects of the external environment would have to be taken into account, especially when markets around the world have been on a free fall during the past several months. Only the most daring optimist would venture out on new investments in these conditions.

The whole planet is almost hard-wired, so it is all affected, said an analyst at a leading American broking firm. It is like the total work stoppage of a nation. This is more relevant now for India as the FIIs have considerable exposure to Indian equities and could influence the status of the market with their actions.

It would only be fair to make a realistic assessment in the aftermath of the recent terrorist attacks in the US, of the prospects of equity as a class of investment in the foreseeable future, bearing in mind the conditions prevailing in the US stock markets both before and after the terrorist attacks. Even before the attacks, there were several indications of an oncoming recession in the world's largest economy and its repercussions on all the other economies, and these stemmed mainly from the following economic indicators:

* Rising unemployment aggravated by lay-offs by companies with falling topline and bottomline growth. Economists believe that the labour market is deteriorating rapidly and that unless there is a significant improvement in employment opportunities, this could be a clear evidence of the US economy inching towards a recession.

* A reduction in consumer-spending, arising from consumers deferring their purchases of anything other than the bare necessities of life, is affecting the profitability of companies in the US, triggering increases in inventories and receivables. Consumers are holding on to whatever money they have and this is having its toll on the economy.

* Cancellation or deferment of capital expenditure by companies which see no benefits arising from the outlay of capital expenditure with long gestation periods in view of the uncertainties caused by a general fall in demand all around.

* A slowdown in the manufacturing sector has affected production significantly in recent months, and companies have had to slash their workforce.

The fourth quarter profits of the US companies are estimated to decline by as much as 15 per cent over the corresponding previous period. Originally estimated at between 2.7 per cent and 5 per cent, the shortfall is now expected to be 15 per cent. This has upset the earlier hopes of a recovery in the economy during the first quarter of 2002, which will probably be much later now.

The business costs arising from these factors such as deferred spending, delayed shipments by manufacturers and cancelled business arrangements, coupled with the economic losses from the terrorist attacks by way of huge insurance claims, rehabilitation costs, and so on, are likely to affect the US economy at least in the next five-six months. Retaliatory military action by the US against the terrorist attacks could further have the effect of sending oil prices soaring and all these do not portend well for the immediate future.

The Federal Reserve which has during the past year cut the interest rates in stages to 3.5 per cent, has further cut the rate by 0.5 per cent to 3 per cent On Monday to sustain confidence in the economy and there is expected to be a further cut by 0.5 per cent before the end of the year. The US Government, in an attempt to forestall any further slowdown in the economy and also to strengthen the global confidence level in the US financial system, has announced a number of measures in the past few days and the more important of these are as follows:

* Easing of restrictions on corporate stock buybacks to bolster market stability. Stock repurchases by companies help demonstrate confidence in the company and the market, in general, and can find ready buyers to prop up prices during a surge in sale orders. Following this move, companies such as IBM, Cisco Systems, BEA Systems, Starbucks, American International Group and H & R Block Inc have all announced repurchase of their stocks of up to $3.5 billion each, over the next two years.

* Leaving in place circuit breakers which halt trading in stocks when prices fall sharply so that further falls are prevented and, also, the facility of short-selling so that trading on the exchanges are kept buoyant.

* Ensuring the easy availability of liquidity in the system by pumping more money into the commercial banks during the short-term.

* Sustaining global confidence in the US financial system by making immediate transfers of $50 billions to the European commercial banks for facilitating the fulfilment of dollar-designated transactions.

Despite all these measures, there is now a general disenchantment in the US among the retail investors for equity, especially as many had burnt their fingers during the great infotech stock boom just as investors in India did. This is driving them to the safety of government securities but as the higher demand has sent the prices of government securities rising, and thus has had the effect of reducing yields.

What is then the picture that emerges from these, especially from the point of view of the Indian investor?

A sagging economy takes its toll on the stock market and, likewise, a falling stock market affects the economy. Government revenues are hit due to lower tax collections from lower capital gains on stocks. Also, investors who sell in this market and book losses will affect tax revenues as and when the market rebounds as they have the advantage of setting off carry-forward capital losses.

The outlook for the US and Japan is rather grim this year and, although there could be improvement in the US economy during the next 6-12 months, there is not likely to be a significant rebound anytime sooner. The picture gets murkier if viewed in the light of the possible US reprisals against the terrorist attacks.

Analysts in the US had looked forward to some indication of the possible course the markets would take upon resumption of trading on September 17 after the longest shutdown of the stock exchanges since the First World War. Despite the interest rate cut, there was heavy selling on the first day of resumption, especially on the industrial stocks, technical stocks on the Nasdaq holding their ground for the greater part of the trading. If this is the pattern that emerges after a long period of shutdown, the markets are likely to remain subdued for the next several months belying any hopes of an immediate recovery.

Some analysts are, in fact, predicting that Nasdaq could well go below the three-digit mark before rising. Any recovery for the Old Economy stocks would probably be preceded by a sustained rally for the first rung technical stocks as there is, as yet, a great apathy for the old brick and mortar companies. The Indian stock markets, which have been moving in tandem with the US exchanges, are also likely to remain dull and in a selling mode, thus strengthening the view that the bottom of the market is not yet in sight. The Indian market could, in fact, be in a for a bigger decline if there is any major selling by any of the FIIs, as was witnessed during the last week and, if this happens, the decline could be more precipitous than at any time before.