It's going down!

For Indian stock market May, 2006 seems to be repeat of May, 2005. The market is plummeting in significant percentage points. As I write this, the BSE sensex after tanking by over 600 points is currently down by 518 points. This is no surprise as everyone expected the market to go down today. This is a part of global meltdown in stock indices.

Yesterday the New York Stock exchange’s Dow Jones index fell by 218 points, the largest fall in 3 years. The bloodbath is unstoppable in Japanese, Hong Kong and London stock exchange. So what is causing the global downfall of stock prices?

The weakening of the stock markets had started on May10th, when US Federal Bank increased the interest rate. When ever the interest rate increases, it mops up the money from the market. Consequently the selling pressure increases and stocks drop. In fact the Federal Bank didn’t stop at this and dropped hints of further rate hike. In all probability, this is going to happen as the inflationary pressure is getting stronger with every passing day. Gold prices are at historic high and so are global crude prices. With the increase in inflation every bank will increase the interest rate. This increases the cost of capital, and effectively lessens the rate of return from market, making it look less attractive.

In India the stock market boom was mainly brought by FIIs. They raised money at cheaper rate in US and invested in India. With the increase of interest rate the cost of raising money in US increased. Retail investors had already significantly stopped exposure in market when the sensex had breached 8000-9000 level. Infact this phase augurs well for Indian stock market. It was long over-due for correction was considered over-valued by some analyst. Also there is one silver lining. With the flight of dollar, the Indian Rupees is set to fall which will boost the topline of the IT industry. Last year the only two months when FIIs were net sellers was May and October, 2005. The market is expected to stabilize and remain range bound within 11000-12000 level in the short term. Investors should not worry and 'Speculators' always have risk appetite. The only point of caution should be for those looking to apply for IPOs having huge premium. In falling stock market large ‘premiums’ are not justified.

In the next few weeks, the inflation figures will determine the direction of stock markets.