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Thursday, October 17th, 2019

Nilesh Shah’s 3 rules for investing in a peak mkt

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by July 20, 2017 General

 

I would like to draw your attention to what is going on in the IPO market and let us be real, there is a little bit of euphoria and a lot of froth. Now the reason why the IPO market is important is because in the previous bull market every time we saw this kind of euphoria in the IPO market, it has always coincided with the market top. A classic example here is when Geometric went public in 2000 and then Reliance Power went public in 2008. We know what happened to equity markets after that?

Definitely in the IPO market today we are seeing one slight amount of euphoria being built because in many of the IPOs, floating stock is very limited and institutional investors or HNIs when they try to build a reasonable position, they end up absorbing the floating stock impacting the prices significantly.

One good thing which SEBI has done is that they have ensured that the quality of businesses which come out in IPO market are significantly superior compared to the past. In 2000, we had seen companies changing their name from finance company to tech company and coming out with an IPO and grabbing money. Today that is not possible. Unless and until, you have a solid business model you do not get clearances from regulatory authorities. We are talking about valuation and not about businesses anymore.

The second thing is that the market also has brought in certain kind of discipline, in 2008, we had seen so many companies whose business models were dependent upon a lot of future probabilities coming true, were able to raise money at exorbitant valuations. Today none of those companies are able to enter the market. They are all leveraged, they desperately need equity, their market cap today is lower than the IPO money or QIP money which they raised in 2008 and yet market is not willing to give them one naya paisa.

So in the IPO market or in the secondary market where floating stock is limited there is some amount of froth but it is about businesses where business model is real, good and solid. It is no longer about dubious business model.

The way how global markets are currently positioned, frankly there is very low volatility and there is serious outperformance in a group called FANG; Facebook, Amazon, Netflix and Google and your Goldman Sachs, your Bank of Americas of the world they are not going anywhere. Do you worry about this concentrated price action which is happening in the US market and if they crack it, could that have an impact on us also?

Undoubtedly today markets are synchronised all over the world but at the same time over a longer period of time fundamentals do prevail. When I started my career, Sensex was half of Dow Jones, today we are far higher than Dow Jones. So clearly as the Indian companies delivered earnings growth, they started getting differentiated vis-à-vis the Dow Jones market. Today the point which you made on volatility is very real. Somewhere the volatility levels have come down dramatically, partly it is coming because interest rates are low all over the world. More than $9 trillion worth of assets are at negative yield. The hurdle rate for equity investment for equity investment has come down dramatically.

Today when I caution a cautious investor that please do not be overweight in equity, he says FD mein mujhe kya milega? (what will I get out of FD?). So his benchmark is a FD, which is mid single digits and hence he does not mind taking the risk. Lower interest rates are fuelling the complacency on volatility.

The second thing, central bankers have behaved like Rajnikant, they have done everything in the last seven-eight years to provide a protection to the market on the downside and hence fund managers and investors have started believing in this put option from the central bankers. If markets correct, if economy comes down they will pump liquidity, they will cut interest rates and hence there is a complacency coming into investors about the global central bankers put. So this combination of lower interest rates and central banks rushing in to support the market and economy at every downfall is creating lower volatility. We do not know how this will pan out.

What is a worry factor right now- the fact that it is a synchronised move across the globe and if global markets were to get a little shaky or volatile that is going to rub off on us as well or the fact that there are pockets of froth already building up or the fact that earnings better catch up because the markets have already priced in a massive recovery coming in?

There are factors which are transient in nature and so the froth in low floating stocks and high exponential growth expectations are in small pockets of the market. Even if they burst, it is not going to have material impact on the overall market. Global synchronisation is something which we can manage, today domestic institutional investors and retail investors put together contribute far more inflows compared to FIIs and my favourite cliché has been that today to sell IPO you just have to visit Bandra Kurla Complex, Lower Parel and Chennai you do not have to go to London, Hong Kong, Singapore, New York.

So as long as there is a reasonable amount of redemption, let us say $10 billion, the local investors will be more than happy to manage that and that would not have material impact on the prices other than transient impact. But the real concern for the market is the earnings recovery. We have seen earnings growing only in certain pockets which are more related to consumer facing, the broad market earnings has been subdued, has been depressed, has remained almost constant for variety of reasons.

What we need to now see how does earnings recover for the broad markets. What is happening in auto, auto components, domestic pharma, building materials and home improvement, cement? Will that start flowing into IT, generic pharma or export related pharma companies, public sector banks, infrastructure companies? We need broad based earnings recoveries for markets to sustain at current level.

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