Chinese-Indian Stock Markets Feel Heat of US Sub-Prime Mortgage Market Meltdown
Global stock markets have been feeling the pressures of the crisis in the US sub-prime lending market since late July.
Indian bourses have been volatile over the past few weeks, taking a cue from global markets. Although India does not have significant direct exposure to the mortgage market, it is not completely insulated. Changes in major global markets have a bearing on investment decisions of foreign funds into Indian equities, as international losses lead to redemption pressures.
Panic selling and offloading by mutual funds led the BSE to shed 1,635 points between July 26 and August 17, while the NSE crashed by 512 points. The worst hit have been short-term players and speculators. Long-term investors will likely recover their losses as long as they back stocks that have consistently rewarded shareholders and are fundamentally strong. It must be noted that the fall in the Indian indices cannot be linked exclusively to one external factor. Political instability within the nation also contributed to the weakening markets.
However, the markets have rebounded as of late with strong gains in capital goods and FMCG stocks. For the week ended August 24, the Sensex closed at 14,424, up by 283 points.
The US meltdown began late last year, when large losses led to the shut down of several sub-prime companies. The US sub-prime market is estimated to be worth more than USD 600 billion. Sub-prime lending is lending made to borrowers who have low income or poor credit histories. In the last decade lenders aggressively targeted this segment of the market as they tried to grow their loan portfolios especially ones that promised higher yields. Many lenders became lax in their scrutiny of loan applications and in many cases gave home loans to borrowers who themselves had not put down any down-payment or “equity” in the property they bought. Many homes were almost 100% financed through loans. Many lenders were giving teaser rates as low as 1% to borrowers initially who are either from low income groups or have poor credit histories during the housing boom. As long as housing prices soared, borrowers were able to refinance or sell properties to make payments and lenders enjoyed the ride. But as housing prices stabilized or came down and borrowers had to start paying normal interest rates it led to a double whammy. Not only did borrowers face equity dilution, but also had to fork out bigger and bigger percentages of their income to pay for their mortgages. It is expected that more than a quarter of these teaser loans will end in default. The impending bust has already taken its toll on several lenders in the sub-prime segment and also on financial institutions that securitize these baskets of loans and sell them as investment instruments. Investors were exposed to investments that now gave me them significantly lower returns than they expected and they started to exit these instruments resulting in a market fall. The impact of this fall has reverberated in all major stock indices globally.
Most real estate benchmarks fell between 9–11 percent over the past month and the Singapore Property Equity Index plummeted 21 percent during the period. Asian indices also followed suit with Asian stocks facing their worst week in 17 years in the week ending August 17. To counter the growing panic, the European Central Bank along with other institutions pumped in emergency funds worth over USD 350 billion into capital markets to facilitate inter bank lending.
In the Indian context, the RBI has always followed a conservative policy for permitting bank exposure in the real estate sectors or capital markets. Since October 2005, it had been proactively raising interest rates and provisioning requirements to counter any impending boom in the real estate sector. With the US Federal Reserve also taking proactive steps, Indian stock markets are expected to remain bullish in the days to come.
The Indian capital markets are riding on the back of strong fundamentals and the positive outlook of companies that are buoyed by a strong economy. The country has high domestic consumption, high savings and investments, good foreign exchange reserves and continued interest from foreign investors, thus inspiring confidence. Given the current scenario, investors should move in when opportunities arise.
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Note: The views expressed here are those of the author and not necessarily of Outlook Money.