A man can live three weeks without food, three days without water, and three minutes without air, but he cannot live three seconds without hope

–   Lewis Mumford.

3 months ago on the 08 March 2014 one share of Unitech cost Rs. 12.10. Today it is trading at Rs. 36.40 a share. What changed so drastically so as to increase the market cap of a company from Rs. 3,165.72 Cr. to Rs. 9,510.25 Cr. in 3 months?

We conducted a poll last week and these were some of the widely specified reasons:

  1. We now have a stable and strong government.
  2. The PM is pro business and has a track record of delivering on development.
  3. Markets are cyclical, they have been down for 6 years, they will turn a corner now.
  4. There is improvement in global economy; and the most promising answer-
  5. Indian markets have been grossly undervalued. The election result just proved to be a trigger for stock prices matching their true worth.

I agree with all of the above. Particularly no. 5. Stock prices really were, and in most cases still are, grossly undervalued.

The biggest truth about stock markets

Stock markets move in cycles continuously undercutting and overshooting the real worth of the underlying security.

Click here to read about my views about the economic outlook for 2014, as they were in August 2013. The stock markets have since then risen by over 50%. Yes, the broader markets are 50% up in less than a year.

The point I am trying to make was most eloquently expressed in the Security Analysis by Graham and Dodd:

General Electric Common Stock Price

Year 1937 1938 1939
Price 647/8 271/4 31

Referring to the above quoted prices, the authors noted –

General Electric sold at 647/8 because the public was in an optimistic frame of mind and at 271/4 because the same people were pessimistic. To speak of these prices as representing “investment values” or the “appraisal of investors” is to do violence either to the English language or to common sense, or both.

Is a 50% Appreciation in stock prices justified?

Economic and political outlook play a crucial role in driving market sentiment. While globally things improved over the last 8-12 months, stock prices in India remained largely dormant mainly on account of government inaction.

On a lighter note, for most of last year, I believed no matter what the next formation looks like or what they do, they will find it hard to beat the previous government in terms of absurdity. Coming from that and then getting the most stable Governement in 30 years, the celebration is not without a reason.

Is this the beginning of the next bull market rally?

While I agree that things can only improve from here on, the appreciation of stock prices over the last few weeks has less to do with a change in fundamentals of the stock and more or almost entirely to do with the hope of a revival in the economy.

Hope is a good thing. It makes people do amazing things. It defies both rationality and logic, but let’s be a little more realistic. How quickly can the Government turn things around? Surely, it will take a few quarters for things to improve? Reforms will have to start again, policies will need to be pushed, businesses will need to start expanding (and hopefully – increasing), and if potential for higher capital return can be demonstrated, direct investments will start flowing back into the country. The way stock markets are reacting, it seems that they have already acquiesced to the happening of all this and more.

Rationality of stock prices has little to do with things right now. The start of the next bull market rally seems to be built on a sense of hope. Hope is enough and is proving to be the biggest driver of stock prices*.

What can the Government do to sustain this bull market rally?

  • Stop Importing, start exporting – I hope we can find crude reserves buried in some part of our country but there is little doubt that pinning hopes to the happening of such a thing will be as pointless as trying to hunt for gold (have we seen that before?). Unless we cut imports, there is hardly a point in competing with China who literally exports everything but oil to our country.
  • Control Inflation – Besides hurting the pockets of the common man the ‘big’ problem with inflation is that it makes businesses and hence the economy of a country less competitive. If input costs are high so is the price of the final product. When fertilizers and seeds are cheap, we can beat Thailand and other countries in the southeast region in exporting rice; when steel and other metal prices go down, our automobile industry will become competitive.
  • Bring in more Corporates to do government work – This may be difficult as every time a company is awarded a contract, eyebrows are raised. The truth is that when delivery and execution is tied to personal profit, highways come about, airports are made and townships flourish.
  • Encourage entrepreneurship – Transform people from job seekers to job providers. I remember when I started out and needed a current account for my business, the bank asked me to furnish a proof of business. When I furnished an electricity bill, it dint bear the trade name of the business and when my first client paid me, he was concerned why he couldn’t cut a check in my firms name.  A lot of what I had to do in the early days seemed like authorities encouraging irregular work. If the next Facebook must come from India then this has to end.
  • Be less absurd / Promote transparency – while the government should maintain secrecy in its dealings, it must put in charge those who answer on behalf of the government.

Things will take time but I am positive. As for markets, there is plenty of value out there and  whether this is the beginning of the next bull market rally or not, the future looks good. Just buy the right things and you will do very well for yourself.

READ BELOW THE PREVIOUS POST ON BUYING STOCKS FOR THE NEXT BULL MARKET RALLY. I WAS NOT IN DOUBT IN JANUARY 2014, I REMAIN IN NO DOUBT RIGHT NOW.