Most readers must have come across the story of monkeys that has come to define the US subprime bubble. That a man can fool villagers into selling monkeys to him at higher and higher prices seems funny. But when the person cons them into buying back the same monkeys in the hope of fetching better prices later, we realize the gaffe. The theory that backs such a foolish behavior is commonly called ‘greater fool theory’. Ironically, whether applied to US subprime bubble or equity markets anywhere in the world, the core of the theory seems relevant.
As per The Economist, despite sufficient history, the greater fool theory has not stopped displaying itself in various forms. The Indian stock markets and investors here are cases in point. Now fundamentals of Indian stock markets are certainly not disconnected to global slump. Corporate earnings therefore are feeling the pinch of poor global GDP growth. But domestic economic woes including lower growth, inflation, deficits and poor infrastructure have played no small part in thwarting the India story. Even then the stock markets seem to be oblivious of the impending risks.
No doubt few Indian companies continue to maintain their fundamental sanctity. But the greater fool theory seems to be coaxing investors into paying much higher prices for the earnings growth. Only in the hope that a greater fool will be willing to buy the expensive stocks from them later at a higher price!
That the Indian government too is using the greater fool theory to its advantage is no secret. By offloading stakes in PSUs to insurance companies and financial institutions, the government wants to cap fiscal deficit. However the very fact that the valuations of such IPOs and FPOs are not exactly cheap confirms the government’s intent.
We believe that the greater fool theory cannot sustain itself forever. Be it Indian investors or FIIs, the realization that the ascent in stock valuations is unreasonable, will be sufficient to scare them away at some point. And investors who try to time the markets might turn out to be the biggest losers in the bargain.