Cover Story: The Coming Crash, Pg 3

Is there a message in the age-old shorthand for the state of the market with respect to its ideal condition--the Price-to-Earnings ratio (P-E)? A simple expression denoting how many rupees marketmen are willing to pay for every rupee that a scrip earns, the p-e ratio of the Sensex stood at 12.76 on June 16, 1998, compared to the dizzying 43 in September, 1994. While the Sensex downslide explains the p-e fall, the question is whether this level is above, below, or equal to what it should reasonably be.

The benchmarks set by the Mumbai-based Society for Capital Market Research Development says that A P-E under 12 for the 100-scrip BSE National Index is low; between 13 and 17 reasonable; and portends an unrealistic high above 18. Currently at 11.36, the p-e should, logically, move upward. But history warns that an abnormally-low p-e also signals a crash. The classic example: in September, 1929, the P-E of the Dow Jones Index had fallen to 13.5 from 15 a year earlier. And, instead of recovering, it culminated in the spectacular Wall Street collapse that started on October 24, 1929. So, far from being a guarantor of recovery, an abnormally low P-E could well be a warning of a crash.

STOCKCAST-III: HEADING FOR 2,515

The bear-grip is being strengthened. Under the classic head-and-shoulders pattern, the ongoing decline should bottom out at a level lying in the range between 80 and 100 per cent of the 870-point vertical distance between 3,851 (the head) and 2,980 (the neckline). But long-term recovery is threatened because the Sensex stood well below the 200-week moving average on June 16, 1998. Had there been a rally upwards from the support level of 3,207.54, a further fall would have been postponed. But now, applying the theory of retracement levels specified by W.D. Gann, support can emerge only between 3,025 and 2,945. But even this will not take the Sensex higher than 3,265. Says Mehmood Khan, 31, assistant manager, Times Guaranty: "Once it penetrates the support level of 2,905, however, even the bottom of 2,713.12 will be challenged, with 2,515 likely to be the next stop." The loss since the last high: 1,807 points.

When do investors lose interest in the bourses? When the banks offer them a higher rate of interest on their deposits. The inverse correlation between the Sensex and the Prime Lending Rate (PLR) is enshrined in history: as the PLR climbed to 19 per cent in 1992-93 and 1993-94, the Sensex hit its three-year bottom of 2,149.73 on July 28, 1993, refusing to climb until the PLR had fallen to 16.50 per cent in 1994-95, and further to 15 per cent in 1995-96. Alongside interest rates, high inflation has always left the field free for the bears.

The prognosis for both contra-indicators spells trouble for share prices. With the government planning a borrowing programme of about Rs 50,000 crore, a liquidity crunch--and a resultant rise in interest rates--is a certainty. Comments UTI Securities' Marshall: "There is concern about the interest rates moving higher. The worry is that higher interest rates are not the result of an economy gathering momentum, but of the increased demand for funds due to the size of the government's borrowing programme." Agrees Rajshekar Iyer, 40, head of research, Kotak Securities: "The rise will be sharp at the short-term end, by at least 150 basis points. At the long-term end, interest rates could harden by about 50 to 75 basis points." Second, the reworking of the major revenue-raising proposals of Budget 98 will leave Sinha with little alternative but to monetise the deficit if he is to sustain the spending spree he has promised business. So, inflation will climb too, doing nothing to rescue the Sensex from the bear that's taking the markets inexorably towards the Crash of 98.

Seven years of liberalisation have irreversibly yoked the fortune of the stockmarkets to the fate of the economy. A responsible institutional player with billions of rupees to safeguard, today's investor will not place his faith in an economy that shows no hope of prosperity. Confused and self-contradictory, the Vajpayee Administration's economic management strategies have not been able to inspire that confidence. For the markets to recover, they must be given the best reason there can be: a tomorrow that promises high growth. Only then will the Crash of 98 become a mere memory instead of staying on as a living reminder of a continuing catastrophe.

THE EMERGING MARKETS CRISIS AND THE CRASH

They've emerged into the dark side of the markets. And, hanging onto their coat-tails, so has India. Between 1994 and 1996, the country's markets benefited from the global diversion of investible funds towards the emerging economies of Asia, Eastern Europe, and South America, seeing the inflows translated into big jumps in stock prices. However, ever since the carnage of stocks and currencies began in East Europe in May, 1997, swiftly rolling across the continent to bring the former tigers to their knees, India has been feeling the heat too. For, as worried fund-managers on Wall Street frenziedly reshuffled their global portfolios to reduce their exposure to the troubled Asian markets, Dalal Street suffered from the pullout.

The original motive behind the worldwide flow of funds into the emerging markets was twofold: first, cash in on the enormous returns from these bourses, which, even after adjusting for the exchange rate, offered dollar-denominated profits far higher than any that fund-managers could expect from the US and Western Europe. And second, hedge against downturns in the US markets, which were usually accompanied by upturns in stock prices in the developing economies.

Today, both motives have disappeared. For starters, the combination of currency devaluation and dropping indices have converted gains into losses. Moreover, the once-tepid markets of Europe and the US are suddenly offering handsome returns, negating the logic of hedging. For instance, over the past 12 months, a portfolio based on the Bombay Stock Exchange Sensitivity Index would have shrunk by 27.80 per cent in dollar terms. Indeed, every index representing returns from emerging markets reflects that trend: the Barings Emerging Markets Index for Asia fell by 59.80 per cent while the Barings Emerging Markets as a whole dropped by 29.80 per cent.

By contrast, the FTA World Europe (except the UK) Index gained 42 per cent, while the MSCI Europe and the HSBC Smaller Europe indices rose by 41.60 per cent and 40.60 per cent, respectively, in dollar terms. Why, even the Dow Jones Industrial gained 16.80 per cent. Obviously, such trends are destroying the very logic of investing in emerging markets like India.

Moreover, as the Indian markets mature, from the global investor's point of view, dollar gains are no longer a one-way road, but a question of correct timing. Since January, 1995, for instance, it wasn't enough for the Foreign Institutional Investors (FII) to merely take a long-term view on their investments. Going by the Sensex, their ideal opportunities for cashing in would have been in June, 1996, or in August, 1997.

The implication: international fund-managers will no longer pour their money into the Indian market and simply sit back in anticipation of profits. They will play the ups and downs actively, which will lead, inevitably, to an ebb and flow in their net exposure. Any market which is dependent as strongly as India is on FII funds, the outcome will, essentially, be large changes in index movements. At least one of which could lead to a collapse, as it has in the case of the Crash Of 98.