Economics assumes that human beings are rational. But human reactions to stock market movements are utterly irrational. When markets rise, everybody cheers. When markets crash — as has been the case for two weeks — everybody moans. A hunt for culprits often ensues. No such hunt is ever announced when the markets are rising. In past scams, when manipulators like Harshad Mehta and Ketan Parekh sent share prices through the roof, they were hailed as geniuses and became celebrities. Some market experts cautioned that the markets had shot up to insane levels. But this plea for sanity was widely dismissed as stupid, and ordinary housewives and college kids bought frenziedly in the belief that share prices could only go up.
However, when the markets inevitably fell, the hero-manipulators were suddenly denounced as villains. They were accused of the dreadful sin of rigging markets, and thus misleading small investors. Ironically, no investor complained as long as the manipulators rigged prices upward. The complaints began only when the manipulators were unable to rig markets any more, and prices crashed. Truth be told, the real public complaint against Harshad Mehta and Ketan Parekh was not that they manipulated prices upward, but that they failed to manipulate it upward forever.
For that, this could not be forgiven. The underlying assumption of small investors is that share prices should rise forever. Now, if the price of rice, sugar or petrol rose forever, the small investor would complain bitterly. Yet he seems to think it perfectly fair that share prices should go up forever, and very unfair if share prices crash. How greedy and hypocritical humans are! Consider the current moaning over the stock market crash.
The fall of the sensex from 12,624 to 10,400 represents a sharp 20% decline within two weeks. But few people seem to remember that sensex was at just 9,390 at the start of 2006. So, even after the crash last Monday, the sensex was still up 10.5% since the start of the year. No bonds or fixed deposits could give such a high return within five months. This point escapes the CPI(M), which sees the market crash as reason enough to stop pension funds from investing in equities.
Remember that the sensex was around 5,000 during the last general election in 2004. It then slumped to 4,282 on panic selling. From that low point, the sensex tripled in two years to 12,624 on May 10, 2006. That has been a bonanza, fuelling speculative frenzy. So, the 20% correction is to be welcomed. Stock market valuations remained stretched by historical standards, though not by developed market standards.
If the sensex falls all the way to the 9.390 level at the start of the year, the market would still have yielded enormous gains to investors since 2004. The long run prospects of the economy are excellent. So, some investor exuberance is understandable. Yet such exuberance needs to be tempered by sharp corrections from time to time. This sends the valuable message that exuberance is no substitute for judgement.
