When reacting to news, the market has a mind of its own

How would you estimate the impact of a seemingly catastrophic event on the stock market? As a major negative of course, as most people in their right senses should. But markets have time and again demonstrated that, when it comes to reacting to news, it pretty much has a mind of its own, i.e. it often shrugs off bad news and moves on higher or ignores apparently good news and reacts negatively.

Let us look at a few cases which support this hypothesis. Chart 1 shows the BSE Sensex from May 21, 1991, the day Rajiv Gandhi was assassinated. Any rational investor would have anticipated that the markets would crash the following day. The next day, the Sensex closed just half a percentage point lower. One month after the event, the market was up 3% and three months later, up 29%.

Chart 2 shows the Sensex after the Tsunami hit India on December 26, 2004. The next day, the Sensex was up 28 points. A week later, it was up 180 points. It then corrected for a month by about 10% before resuming its upward journey.

Apart from the colossal loss of human life and personal tragedy, this event was expected to inflict heavy rebuilding and relocation costs on the national exchequer. But as we see from the Sensex movement, the markets just shrugged it off.

Around August 2007, it was well and truly established that the simmering problems in the US subprime markets were going to blow up. During all of 2007, lenders in the US had begun foreclosure proceedings against 1.3 million properties, an increase of 79% over 2006. It was apparent that danger lurked around the corner and that caution was indicated as far as equity markets were concerned. And what did our markets do? The Sensex went up from 14,000 points to roughly 21,000, a gain of nearly 50% in five months!

When the markets started their current upward movement from March 9, 2009, there was no apparent trigger for them to do so. In fact, India was faced with the prospect of a hung parliament, the most likely outcome of an election scheduled for two months later. The subprime crisis was nowhere near its end and Indian corporates were strapped for cash to fund their massive expansion plans and international buyouts. Even as you read this, markets have more than doubled from their lows, and are widely expected to go even higher. Economists are once again projecting 8-9% GDP growth rates and companies are increasing their profit guidance.

So what is the point of all this? Simply that markets have a mind of their own.

Markets are made up of individual participants, although they are sometimes lumped into categories like mutual funds, FII’s, HNI’s, retail and so on. But the institutional investor comprises human beings who make decisions and are driven by the same emotions of greed and fear that affect the retail investor. It is the collective interpretation of the future that drives markets, not the current news.

This is not to say that every time there is a major event, the markets will simply ignore it. This exercise is meant to highlight the fact that markets will pretty much do what they want to, regardless of news or events.

(The writer is proprietor of Capital Management Services)