Whatever happened on the Indian stock market on Monday 20th June was inevitable, however, the reasons chosen by market participants to hammer down the stocks was an aberration. But that's the way markets tend to behave if we try to understand it from the 'Behavioural Finance' perspective. The sharp knee jerk reaction to the news on Indo-Mauritius Tax Treaty can be explained through behavioural biases which market participants tend to follow. The reaction of Monday was a result of two commonly observed biases;
1. Availability Bias: Investors tend to heavily weigh their decisions more towards recent information which is widely available in the public domain. Availability is affected by various factors such as source of information, ease of remembrance, reaction time. Very often market participants overreact to new information leading to a dis-proportionate movement in market indices. The news on the review of Indo-Mauritian Tax treaty is as old as 3 months, and even if the changes are agreed to between the two countries the same will be implemented with a time lag of at least 6 months. The market reacted the way it did because of the reasons explained above.
2. Herd Mentality: It is the tendency of an individual to mimic the actions of a larger group, without bothering whether they are rational or irrational. The reasons for herd mentality are: i) a large number of people cannot be wrong, ii) social pressure of conformity. Investors influenced by the herd mentality constantly buy and sell their holdings based on the current investment trends. The initial reaction by a few FII's on Monday was to take advantage of the news on Indo-Mauritian Tax Treaty and press for stock sale, soon the herd mentality gripped the market and within seconds the stock indices started tumbling.
However, there is no need to press the panic button. I continue to hold a view that the markets are going to go down in the medium term, but that will not happen in a hurry. On the contrary, what has happened to the markets on Monday is extremely positive in the very short term. The markets in panic did touch their immediate support levels of around 5200, albeit briefly, on Monday. There is a very strong possibility of a strong rebound in the coming weeks which is likely to pull the market back to around 5450-5500 levels on the Nifty or even higher. But investors are advised to book profits on every rise in the momentum stocks, the likes of GTL group stocks which crashed by 40-60% in just one trading session. The list of such stocks is endless. The front line indices may go down to 4800-4900 levels on the Nifty, before the next bull run resumes. If that is going to happen, the probability of which is quite high, the Mid cap and Small cap indices may tank up to 15- 20%. But, as I said, this is not going to happen in a hurry. The events likely to trigger such a slide could be:
- Fall/ Major shake up in the Central Government: You cannot afford to overlook this scenario anymore with the kind of mess the Govt. finds itself at this juncture. If at all this Govt. has survived this long is through the generosity of the principal opposition party, which is in the middle of an even bigger mess.
- Real Estate Crash: A bubble seems to be forming in the real estate sector. When this bubble will burst is any body's guess. Real estate growth is sustained in an easy liquidity scenario, a real estate crises is waiting to happen once liquidity dries up. This could happen anytime when highly liquid FII's, Hedge funds take a flight out of India.
