Haphazard Linkages

The following charts are useful in appreciating the previous bull market in India. Improving interest coverage ratios and uptick in growth in the first half of the previous decade created a favourable environment for assuming a long equities posture. The acceleration in equities post 2005 coincided with a down tick in debt service capacity. This is in tune with behavioural characteristic of investor attention reacting belatedly to fundamentals. Cut to the present, coverage ratio is at 12-year lows and yet the equity index is at levels similar to 2007, when coverage ratios and economic growth were vastly better.  Improving balance sheet health also reflected in a down tick in interest expenses relative to revenue until 2006. Post 2006, this metric has evolved on a deteriorating trend, and bank gross NPAs have grown at an accelerated pace. Both are at 12-year highs. The broad economic slowdown is partly to blame; however, blame ought to be apportioned to bull ma...

In what should evolve into a multi-part series, Mind of the Market will endeavour to peer under the hood of the largest laboratory of human psychology in the world; the financial markets. Where frigid numbers and emotive participants spar enthusiastically in an elaborate and often bewildering drama-in-motion. Where apparitions and reality merge so finely as to be mostly indistinguishable. Where paradoxes and circular relationships reign supreme, frequently, and fervently, questioning the very essence of rationality and cause-and-effect. Part I addresses the dynamics of Pavlovian Conditioning and market participant response to stimuli in investment decision-making. Intriguing paradoxes and the behaviour of asset prices - a cause (and consequence) of market participant response - is considered concomitantly. Finally, the psychology of herding closes Part I. Pavlovian Conditioning and Asset Price Behaviour When Ivan Pavlov discovered his lasting contribution to humanity - Class...

The Day of Resurrection is probably an opportune moment to pause and gauge the pulse of the market. After the forgettable dalliance with 2011, risk assets seem to have found an amenable ally in 2012 so far. Tepid interest from FII towards India in 2011 has been replaced by renewed fervour ($9 billion net inflows in 1Q2012 v/s -c.$1 billion net outflow in 2011).  Interestingly, very little has changed fundamentally. The March budget was a damn squib, with the Finance Minister hoping to walk the tight rope between taming inflation, curbing a burgeoning fiscal deficit, without fettering growth. The Budget was, however, low on major reforms and irksome issues continue to make their presence felt. Yet, FII continue to pile in.  One of the intriguing things about human behaviour is its stickiness in altering the status quo prevailing bias. After a prolonged period of bull market, bearishness/pessimism is a rarity; likewise, after a bearish period, bullishness/optimism ...

An abrupt market drop causes a rally in gloom-n-doom hypotheses. More than a few that landed in my inbox recently focused on the relationship between corporate profits and GDP. The core theme was this: corporate profits as a percentage of GDP exhibit a mean-reverting characteristic. Whenever they overshoot too far from the mean, they fall back; and this isn’t good for long-term equity returns. Current levels are close to historical highs, so equity bears invoke the above to build a bear case. Historical references cite the peaks hit in 1965/66 and 2006 as strong evidence for weak subsequent equity performance. History provides some insights. The following exhibit uses after-tax corporate profits from NIPA and uses the Dow Jones Industrial Average as a barometer of equity performance. The DJIA was chosen as a longish history of prices was readily available. For comparative purposes, a similar exhibit for the S&P 500 is appended later.    Only 2 out of th...