It is said history doesn’t repeat itself, but it rhymes. Here we look at previous boom-bust cycles in the Indian stock market to analyse if the winners of a previous bull run, are able to repeat their performance in the next.
This analysis is relevant and topical in India at this point of time, because the Indian market, after a long hiatus of more than six years, has crossed the previous high, and clearly there seems to be growing excitement that we might be at the cusp of the next bull run. Undoubtedly a lot of hope is centered around the newly formed Narendra Modi-led government.
Equally important is the fact that many macro indicators have remained low for a long period and there might be early signs of a turnaround, albeit a moderate one.
Many investors obsess about headline index levels, often missing out the main contributors and detractors in these market movements. In short, it might be entirely possible that investors get the market direction correct, but end up with stocks in their portfolios that are under-performing the market. One of the common reasons this happens, is because of the tendency of investors to look at the big winners of the previous bull market and to assume that they would re-emerge as winners in the next bull run. Markets in their own characteristic fashion offer early signals that reinforce this flawed belief.
In the bust that follows the boom, the leaders of the previous bull run, after an exaggerated rally, typically see a very sharp correction in stock prices. Hence it is quite natural that in the early stages of the next market run up, owing to reasons attributable to pure mean reversion, some of these stocks see a sharp bounce from their low price levels. In short the stocks hit the hardest, appear to be regaining their leadership position, but this typically does not last. After recouping some lost performance, these stocks lose their sheen. In short, it is more likely a mean reversion trap rather than a return of leadership position.
Investors would do well to avoid this trap, unless they are extremely smart traders and can dispassionately catch the near-low and near-high points of the mean reverting trade with agility.
Consider the case of the Indian information technology sector in the year 2000. After the bubble burst in March 2000 tech stocks took a severe beating. However, there was a 57% echo rally from March to June 2000 that created the illusion that tech stocks could stage a comeback. The common arguments we heard then was that the dot com meltdown impacted internet companies in the developed markets that relied only on eyeballs and had no real business model, whereas the Indian IT sector had solid fundamentals. Well it might have been true, but clearly at price earnings multiples of 100x the stocks were building in a growth trajectory that could not be sustained.
Similarly, the Industrials sector saw a huge rally from 2002 to 2007, rising more than 20 times from the lows. In the bust that followed in early 2008, the sector fell 78%. This was followed by a strong echo rally of 258% from the lows, but that has since faded, although not without many half-hearted attempts to make a comeback.
A common refrain we hear from investors is that India is an infrastructure deficit country and this sector will naturally see a resurgence in the stock markets. While the importance of the sector from the viewpoint of the Indian economy cannot be disputed, what is often forgotten is that the 2002-2007 phase saw these companies earn super-normal profits, thanks to crony capitalism. And that is unlikely to repeat.
It is almost impossible to predict with precision where the ‘next new thing’ could emerge from. However we typically notice a few common traits in the early stages of the emergence of the ‘next new thing’ in the markets.
1. Few listed stocks
New listings typically follow after the sector is already in the limelight. The infrastructure related sectors saw more than 50 new Initial Public Offerings, or IPOs, from 2004-2008, raising a total of about $10 billion.
2. Low or almost no sell side research coverage
Unitech and Punj Lloyd were two popular stocks in the Infrastructure-Real Estate sectors which were the darlings of the market during the infrastructure sector boom saw a spike in sell side coverage after the stocks had already peaked out. After many failed attempts to regain leadership in the market, these stocks eventually saw fading sell-side coverage.
3. Low representation in benchmark indices
Take the case of the real estate sector in India. There were just 5 real estate stocks in the broader S&P BSE500 index in April 2003 with a market capitalization of about $63 million. By the time the sector peaked in December 2007, there were 20 real estate stocks in the same index with a market capitalization of $97 billion. The infrastructure and real estate related stocks in the broader S&P BSE500 Index rose from a low of 10% weight in the index in 2003 to as high as 28% in 2007, contributed both by new stock additions in the index and price performance.
Some trends fail to live up to their initial expectations whereas others could become game-changers. To see which trends might throw up interesting investing opportunities in the coming decade, read Investing themes to consider.
This article has been contributed by Amay Hattangadi and Swanand Kelkar of Morgan Stanley Investment Management.
