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The Stock Market Crash Course

The Stock Market Crash Course
Madhavankutty Pillai has no specialisations whatsoever. He is among the last of the generalists. And also Open chief of bureau, Mumbai  
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The nature of global markets makes it difficult to pinpoint a trigger for such an event

NO ONE LIKES taxes, and in a fair world, any tax should be in proportion to what it gets citizens. In Scandinavian countries, taxpayers don’t crib when more than half their income is taken by the government because in return they get top-class free medical care and roads that are spotlessly level. India’s thin 2-3 per cent tax-paying class, which believes itself bearing a burden for the rest of the country, feels fleeced but pays up nevertheless because there is no alternative. That is why the return of a Long Term Capital Gains (LTCG) tax on stocks in this Budget provoked anger among the few who invest in equity. The earlier LTCG holiday was patently an unfair exception—after all, nothing makes shareholders more eligible for such a bonus than flat owners— but it was the only investing domain to make legitimate money without the state claiming a share of it. When Indian stock markets crashed the next day, with the Sensex tanking almost 1,000 points at its low, remonstrations erupted: the gains are all gone, what will you tax now?

The vindication was misplaced. It was not just in India, but stock markets across the world that crashed and kept sliding for much of the week until there was a bounce. Between February 1st and 6th, the NSE Nifty index fell about 800 points from 11,100 before clawing back. The Dow Index that measures the main US market fell by over 2,000 points in five days. The Nikkei of Japan, again by 2,000 points or so. The world crashed, taking India along with it.

The nature of global markets makes it difficult to pinpoint a trigger for such an event, but one major reason for any collapse has nothing to do with humans. Most big trading now is entirely driven by mathematical algorithms that automatically trigger buys and sells based on how prices are moving. At some point, a domino effect takes over to turn a dip into a collapse. The US Treasury Secretary Steven Mnuchin said as much on February 6th. A CNBC report said, ‘Speaking as the market was seeing yet another down day during a rough February, Mnuchin addressed several questions from House Financial Services Committee members about the sell-off that has knocked the Dow off nearly 9 per cent from its most recent high. Automated algorithmic trading “definitely had an impact” Monday when the blue-chip index was down nearly 1,600 points, at its low point of the day, he said. However, he said, even though the bots did take over at one point, the overall market functioning was fine. Algorithms control much of market trading now and are programmed to buy and sell based on certain triggers.’

For more than a year now, stock markets have done nothing but go up without a break. Those who are aware of the historical behaviour of markets have been cautioning that good things don’t last forever, but the history of bubbles is also about such warnings going unheeded. At some point there had to be a correction and this was it. For the large number of investors who jumped in to make a quick buck, there is however now the sudden realisation that buying shares or mutual funds can also lead to loss of money. It is not the one-way street to riches that their brokers promise. The first principle of all investing—greater the risk, greater the reward— is a lesson that everyone learns sooner or later in equities.

Greed is a powerful impetus and, without a few more blows, it will continue to rule. Bull and bear markets can drag on for a while and people’s behaviour changes only with experience. Traders, which is what most people are who put money in stocks with a horizon less than a couple of years, usually make a lot of money in the beginning of bull markets and lose more in the end because of habits they’ve created in themselves. There is, however, an almost guaranteed way to make money on equities if you think of owning a stock as becoming part owner of the business. Then all you need to do is monitor the firm’s performance and not its stock price. Ultimately, the two have to converge. This is the method that Warren Buffett, who created a $100-billion company from scratch by buying and holding good companies, advocates. In his 2013 letter to stockholders of his company Berkshire Hathaway, he listed the fundamentals of investing that began with: ‘You don’t need to be an expert in order to achieve satisfactory investment returns…When promised quick profits, respond with a quick “no.”’ He also warned against taking decisions based on price movements of stocks, calling it speculation. He wrote, ‘There is nothing improper about that. I know, however, that I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so. Half of all coin-flippers will win their first toss; none of those winners has an expectation of profit if he continues to play the game. And the fact that a given asset has appreciated in the recent past is never a reason to buy it.’ It is free advice from the greatest investor of this age. Those who decided to sell after the recent correction or are now planning to buy because of the upswing should perhaps heed it. But they will probably not.