Sensex Crosses 20,000: Irrational Exuberance?

BSE Sensex : 32 months ago and today (Source: Google Finance)

The Sensex on Tuesday just barely crossed the 20,000 mark to close at 20001.55 and its fellow benchmark index Nifty closed at 6009.05. There is something very different about the 20,000 mark. It is a limiting psychological barrier, especially since the last time the Sensex crossed it was followed by its worst fall in history (see chart). The stock markets have become a prominent discussion; especially with some people who become over enthusiastic and share anecdotes of their previous heroic encounters of riding the Bull Run. Some are still recovering from the last of the bear claws, and there are most importantly others who are confused and yet obdurate of investing in the markets. For they know if they can pull this one off, it will be remembered by one and all.

The whole dilemma surrounds the principle notion of “this time is different”. But is it really so? Can we be sure that the crash from the peak of 20,000 in 2008, about 32 months ago will not happen again. Can the market pundits on the TV quell our fears about the market, and encourage us to make a quick buck before Diwali? Well nobody can predict the right answers, but we at least have to acknowledge that time is not constant, and whatever the present conditions, this time will never be different.

Source : NSE

The first question, then, is to ask who paid for this ride? FIIs have put in record amounts of money in the stock market this year. The above chart I have assembled shows how currently FII have been strong resilient net buyers and domestic investors are selling their investments. The domestic investors are probably not confident of the market so much and definitely when the Sensex is in the 18,500+ range.

Indian markets are a good bet for foreign investors for whom the lack of good investment opportunities in the West is making them look East. There are still some worries about the debt-laden Euro nations. The recovery in America has been very pale as the Fed prepares for another round of Quantitative Easing. Gold a negative barometer of economic expectations has been touching all time highs in recent weeks.

This leads to my second question, so how long will the Sensex hover above the 20,000 level? Well there is a slight idea that it could be as long as the foreign investors want to stay put in the Indian markets, which implies as long as no other attractive investment opportunities emerge elsewhere outside India. But it leaves us thinking that would the FII continue the bull rally in coming months and achieve record heights, or simply book profits and correct.

Again all this depends on the markets perception of the fundamentals of the stocks. India’s P/E ratios remain higher compared to the P/E ratios across the rest of the world. While some analysts have said that the coming quarterly results might be rather dull, others are expecting a stable market till Diwali followed by a market correction. 

Source: Stockezy.com

Coming to the last and most important question that is this the right time to invest in the markets? If you were till now expecting a clear answer from me, I am sorry to disappoint you. I am still not convinced about the reasons to be bullish or bearish, and I am not the only one. Well that’s also what the market has been thinking in the last couple of weeks. Have look at the NSE VIX, which measures on the basis of existing options contracts, the market’s expectations in the coming days or months. High volatility in recent weeks shows how investors are currently viewing the market’s situation.

To sum it up, the market can be judged to thriving on exuberance and optimism, whether it is rational or irrational, only time will tell. I think it will be prudent and wise for me to sit out of this fight and leave it for the biggies to clean up. Will you too?

Indian Stock Exchanges Going Global?

I have written previously about how global markets are getting more integrated and showing signs of high correlation.  Regarding this, I had also highlighted the point of imperfect information dissemination and how domestic markets have changed.  The previous article talked about how exchanges and other capital markets, which were earlier domestic in nature, especially of emerging economies such as India have now gone global or have initiated the process of doing so.

A valid concern then arises whether any of our stock exchanges have the ability and necessity to become truly global. Ability? Of course yes. India enjoys a strong technological advantage, thanks to its IT sector. Supplemented with the appropriate investor friendly policy environment, India has better chances in comparison to its competitors. Furthermore, necessity, as economics teaches us, arises from a near inelastic demand curve. And presently, I would say that this inelastic demand is present in the form of the huge investor interest in the growing returns of the securities of Indian capital markets.

As I write, the US short term interest rates are close to zero, and the US long term rates are around 2-3 %. The interest rate prevailing in India is currently around the 6-7 % range. Thus, this vast interest rate differential makes a compelling case for carry trade. But cash- laden investors in the West are looking for even higher returns in the form of equities.

The question we should be asking to ourselves is that, can Indian stock exchanges make it big on the international stage in the next 10-20 years? I say yes.

India is among the many emerging economies that they consider and competing for the same factors of production and markets for its production. The race to fight for these economic resources and markets for sale has only intensified since the economic crisis begun.

The race for other factors of production shall continue, but I would like to focus on capital as the most necessary factor for the coming years. Capital is a very important input for growing economies and if India needs to sustain existing growth levels of 9%, it has to tap external savings and investments. In simple economic terms, investments in an economy are equal to the domestic savings, budget surplus and net imports. Hence increasing capital inflows in the form of foreign investments on the NSE traded stocks will be a great boost to the Indian economy.

Just recently in May, when the government announced plans for compulsory 25% stake sale in all listed public companies, there was a lot of hue and cry over whether the market would have enough liquidity to absorb  so much of stake sale. The estimated amount of equity issuances over the next 3 years is around $30 billion. This amount is trivial in comparison to what large corporations in the US issue. For instance, HP is planning to come out with a $33 billion bond issue in the coming weeks.

Another important factor is competitiveness among the national exchanges itself. NSE is closely followed by BSE and another MCX-SX is waiting in the docks If not NSE then there will be some other exchange. But in my opinion, with its current position in terms of the market position, management and technology advantage, NSE is the most amenable to such expansion.  

NSE has recently signed a cross listing agreement for futures of flagship indices with CME and earlier with SGX, but these listings are just to give foreign investors a feel of Indian markets and assist  in portfolio diversification. The real deal will be when the NSE can convert the volumes and listing numbers the large foreign bourses boast about.

My last argument for having such high hopes of seeing an Indian stock exchange reach the heights of a global exchange is the comparative advantage Indian capital markets have over other emerging economies markets. In the recent World Economic Forum’s Global Competitiveness Index, although India fell two places to 51st rank, its financial markets were rated 17th across the world. This shows how the existing level of competitiveness in the Indian exchanges and the future can be built on this grounding.

NSE to NYSE !!

In a surprise response to my previous post, a lot of my peers have asked me how our exchanges can dream of going global, when after all they are 'desi'. One even quipped that beggars can't be choosers! But I stand firm with my belief and to prove my point, enlist the following things below, which could see NSE becoming another NYSE, along with the significant premise of India becoming a superpower.

Firstly, let me make it clear why I chose NSE over its bitter rival BSE. Ever since the launch of NSE and its electronic trading platforms, the BSE has been playing catch up all the while. So for me, amongst Indian stock exchange contenders, NSE comes above all. BSE has a lot to do to set its house in order.

Second, although NSE should dream global, it should currently set its target on regional dominance. In my opinion, the ideal strategy would be for NSE to try and spread its reach in the next 5 years or so by becoming the dominant stock exchange of the Indian subcontinent. The secondary capital markets of India’s neighbors are not known for their price discovery and liquidity. Thus, for the large firms in the subcontinent, which are looking for raising large capital NSE can be a more viable option instead of looking westwards.

The process of transforming the NSE to South East Asia’s major bourse will be a learning experience for the exchange and regulatory authorities. Many structural changes would be required, but these will only lead to the ultimate goal of being the world’s dominant stock exchange.

On the regulatory side it will require a lot of push and pull as well. This leads to my third point, about capital account convertibility. The foreign investment environment should be completely freed from any capital convertibility controls, which if present will be a big problem for expanding the NSE’s reach globally.

Fourth, its listing requirements will have to be adjusted from time to time, although I am bullish on the INR, it will be safe to assume that dollar could still be the unit of account. Looking at the short term i.e. in the next 7-8 years INR could continue to be in the listing norms and even the currency for transaction. Various macroeconomic variables in the future will decide whether INR will continue to be the global NSE’s transaction currency.

NSE should currently set its target on regional dominance... the dominant stock exchange of the Indian subcontinent... for the large firms in the subcontinent, which are looking for raising large capital NSE can be a more viable option instead of looking westwards.

Second on the regulatory radar and fifth overall, is the change in the accounting standards subjected to the firms listed on the exchange. Investor confidence is one of the fundamental requirements for building this global exchange. Therefore, a common measure to assess companies listed and the overall index products of the exchange would be facilitated by a recognized accounting standard. Maybe the IFRS or an evolved version the IAS; this only time will tell.

Sixth, we need to see rapid expansion on the products being offered by the NSE. Although it lost out to the Bombay stock Exchange for the country’s first IDR, this will serve as a rude wakeup call and set the ball rolling.  Foreign companies are looking for bullish and deep capital markets like India to raise money in the form of IDRs and foreign bond issues. NSE has to be ready to be able to provide that kind of platform and logistics to gain from the coming opportunity in times ahead.

Seventh, would be to build partnerships with other foreign bourses. NSE already has Nifty futures trading on the Singapore Stock Exchange, and just recently has tied up with the Chicago Mercantile Exchange for cross listing of index futures. Nifty futures will be traded on the CME, while the Dow Jones and S&P 500 futures will be traded on the NSE. The move is a step towards alignment to global markets.

This is a great opportunity for the clients in India who are looking for portfolio diversification. We have largely seen a homeward bias from clients so far, maybe because of a lack of opportunity from diversify, but I believe this will be beneficial for them in terms of their portfolios as well as having a global perspective.

The Hindu Business Line reported:

“According to market participants, trading in SGX Nifty futures has been happening almost a decade but volumes picked up only in the last couple of years. At the end of April 2010, open interest stood at 1, 91,741 contracts, which are 65 per cent more than a year-ago period, according to SGX. Trading volumes surged to 7, 79,641 contracts, which are 52 per cent higher over a year.

As part of the agreement, Indian rupee-denominated S&P 500 futures contracts will be listed for trading on the NSE and in return CME will list U.S. dollar-denominated contracts on India's benchmark stock index futures contract, the S&P Nifty.”

NSE faces many short term challenges and within them growth possibilities, which could very well decide its future. With an eye on global partnerships it needs to fend of a coming rival...

The National Stock Exchange (NSE) has signed a letter of intent along with London Stock Exchange (LSE) to evaluate cross listing of index products as well as explore joint strategic opportunities. Both the bourses have explored the possibility of a cross-listing agreement of their flagship indices.

While FTSE Group may license the FTSE 100 index to the NSE, the bourse would license the Nifty to LSE for trading option contracts. Initially, only Nifty options will be considered for listing at LSE as NSE already has licensed Chicago Mercantile Exchange (CME) for trading Nifty futures contracts.

Also recently, there were reports of NSE being in talks with Japan’s Tokyo Stock Exchange, exploring probably what reports suggested was cross listing of the two exchanges’ flagship index futures.

Eighth, NSE faces many short term challenges and within them growth possibilities, which could very well decide its future. With an eye on global partnerships it needs to fend of a coming rival, the Multi Commodity Exchange of India Ltd. It needs to fully exploit the growth potential in India before looking beyond its shores.

While researching online I found an interview of the CEO, NSE who was talking about his firm’s plans future plans in India:

“One is to go out increasingly to underserved market those that are smaller in terms of not being economically viable for intermediaries. To improve the economics of serving in those areas, they may try helping brokers by picking up the tab on public infrastructure. Increasingly, that will try to reduce the cost of commercial public infrastructure, so the brokers do not feel the disincentive to service them. That may bring in the so-called marginal investors.

Second, the derivatives arena will continue to evolve, unlike cash equity which typically moves at gross domestic product (GDP) plus (rates). The plus comes from some chunks of the unlisted economy becoming listed. Derivatives will continue to bring out newer products and services.

Third, the domestic institutional sector still doesn’t use derivatives. Domestic institutions are beginning to get used to these products. Mutual funds are beginning to use a bit but still a small proportion; that would increase.

Fourth, newer asset classes—currency, interest rates are classic products which really need hedging. Arguably, the two most important prices are currency and interest rates, but they are hard to hedge. That will build over a period of time.”