Will stock markets continue to soar?

One of the things that make the current bull run in the Indian stock markets somewhat different from previous rallies is its indifference to bad news. Historically, "negative news flow", the phrase that market hands use to describe all sorts of adverse events, has triggered fairly significant corrections in the market.

By that token, one would have expected the news of the Bombay High disaster to have caused quite a flutter across a broad range of stocks. There would be anxiety not just about ONGC's bottom line but about India's energy sufficiency in general.

There would be questions about the impact on oil imports, the consequences for domestic prices of oil and oil products, the exchange rate, and so on. The market would have taken a breather, moved down a bit and when there was greater clarity on these issues, resumed its upward journey.

However, look at what happened the day after the disaster. Apart from a relatively small dip in ONGC's price, the adrenalin rush in the markets continued.

What is particularly surprising is the bourse's apathy to what is going on in Indian politics. Traditionally, the equity markets have been somewhat excessively sensitive to negative vibes from New Delhi and I would have expected the Bhel imbroglio, for instance, to shave a couple of hundred points off the market indices.

However, investors didn't bat an eyelid and the prolonged impasse over the divestment decision hasn't even made a dent in Bhel's stock price.

I have heard two sets of somewhat unrelated explanations for this change visible in investor behaviour. (By "investor" I refer almost entirely to foreign funds, which have almost driven the current market uptick. Local investors have either stayed on the sidelines or have actually sold into the rally.) The first explanation refers to the changing profile of funds that are placing their bets on India.

There is apparently a new class of investors who are in the market for the first time and whose expectations from the Indian markets and investment horizon differ from the older FIIs, who have been active since the Indian markets opened up in the early nineties. An example of this new breed would be the Japanese funds, who have been seriously investing in India just for about a year and a half.

The new funds share the following characteristics. First, they appear to be sold on two aspects of the "India" story -- one, the fact that India's domestic markets have reached a kind of inflexion point beyond which growth rates will be sustainably higher, and, two, that the quality of corporate governance matches international standards.

Second, these investors are not looking for short-term capital gains but are in it for the long haul. Thus, transient bad news really doesn't really hurt them much. Their assessment of what constitutes a "fair price" depends not so much on what happens to profits in 2005 or 2006 but what seems like a sustainable bottom line over a longer horizon.

What about the fact that the Indian political and policy scenario looks fuzzier than ever, with the Left playing party pooper when it comes to critical economic policies like privatisation? The response from this new class of investors is the following: Indian companies have learnt to survive and thrive in this policy environment.

They will continue to do so even if radical economic reforms don't go through. Given the current regulatory standards and transparency, it makes sense for investors to take a "portfolio" exposure to India. Policies and politics are more of a constraint for foreign direct investors. For them, China, which is far more nimble with economic policy and has a friendlier investment regime, remains the preferred choice.

Besides, most of these investors view the nexus between politics and economic policy as largely confined to the fiscal domain. Let me try and explain this somewhat simplistically.

If, for instance, the government does not divest, or is unable pare subsidies, its ultimate impact is that the budget deficit is likely to bloat. So the manifestation of bad economic policy choices is essentially in the fisc.

"So what?" these investors seem to ask. Do fiscal imbalances really matter? The US has seen its budget balance move from a surplus to a large deficit over a few years and yet the US growth engine has chugged along.

Multilateral institutions and rating agencies may choose to whine about growing domestic debt and a large budget deficit, but, for these new investors, fiscal rectitude doesn't quite figure very high on their list of priorities. Bad public finances or not, Indian companies' bottom line will continue to grow.

The second explanation for the market's untrammelled upward momentum is the fact that there is a surfeit of liquidity sloshing around in the global financial system that is seeking returns. Economic prospects in Europe continue to look bleak with average growth in the region at around 1 per cent.

There are growing concerns as well about the US's ability to sustain its growth momentum (the last round of TIC data shows private investment flows have virtually dried up). Contrast this with India, where even in a bad year, 6 per cent growth is guaranteed.

Moreover, India's domestic market is huge and its dependence on the global cycle less. Corporate profits look strong and a few glitches like a disagreement within the ruling coalition over a divestment decision don't really matter. As long as there's spare cash to invest, Indian markets are likely to get a share.

What do these new trends augur for the India market in the near future? Well, the bull run will end either if this new breed of investors runs out of cash, or if global liquidity dries up. Neither seems likely.

With China revaluing its currency, thus setting the stage for a downward correction of the dollar against most Asian currencies, most Asian central bankers would be loath to tighten their monetary strings. (Tighter monetary policy would mean higher interest rates and a stronger pressure for their currencies to move up, making their exports less attractive in the process.) This should help keep liquidity levels high. As for the new set of investors, there is no evidence to suggest that their funds are drying up.

So the upward momentum is likely to continue.

I am too old-fashioned to believe that there will be no corrections along the way. Someone is bound to panic and book profits as prices swell further and this could induce dips.

But buyers are not exactly scarce and each of these dips is unlikely to be very large. Market watchers who are flummoxed by the strange turn of events in the equity markets perhaps need to recognise that there is a new paradigm of investment at work.