Has the Stock Market Bubble started?

The BSE Sensex has crossed the 19000 mark. The sentiment is bullish with FII’s entering the markets and chasing stocks. Why not? Elsewhere in the world there are hardly any worthwhile opportunities to invest in. The interest rates are also very low. Just barely 18 months ago investors were shunning stocks when they were available at most attractive valuations. However today when the prices are rising investors are finding the stocks very attractive. How strange is it? Investors find a stock less risky when the prices are going up and everyone is buying and they find it more risky when prices are down and nobody is buying. Lest we get swayed by the herd in the markets it is important to revisit some wisdom learnt from the last bull market. Is there a build up of a bubble? Yes. Good news are trickling in and the markets are going up on each good news. Any bad news are discounted. The situation is such that there are no bad news at all. One by one like a game of musical chairs we see stocks in all sectors going up. Listen to your favorite business news channel and you become more optimistic as all the available information is positive. Analysts and fund managers show over confidence and over optimism and predict the markets. Investors feel overconfident as their stock prices are going up. They attribute this success to their ability and knowledge to pick stocks. They thus turn in to investment managers in their own sphere of influence. IPO’s are lined up to cash in on the present boom. Last year you had some IPO’s but investors did not make money on listing. Hence the euphoria did not last. However this year with the successful IPO of SKS micro finance investors experienced listing gains. Some other listing gains did follow. The index is climbing up and IPO’s are offering listing gains. Management of companies have lined up to en cash on the euphoria of the investors.Well this is a sure sign of a bubble in the making. With stock prices going up values are difficult to find. When that happens and investors want to invest at any cost the “Greater Fool Theory ” works. Investors are not bothered about valuations but they are buying because others are buying  even though the prices are high. The hope is that there will be another fool to buy it from them at a still higher price. People are not investing but in the guise of investing they are trading and speculating.

So what does one do? I am in no way suggesting that one should sell of all stocks and sit liquid. Stocks are still the best investment opportunities today as they are the best hedge against inflation. Fixed income securities will definitely erode your purchasing power in inflationary situations. Knowing that equities are risky and you are still an investor you are not risk averse. However the problem is that investors make mistakes in the stock markets because they are loss averse. Now is the time not to be loss averse. Ride your winners and sell your losers. Such bullish crazy times can go for an extended period. The challenge will be to ride your winners and sit tight. Do not make the mistake of allocating more resources to stocks at present unless you see a great value. Enjoy the bull run without participating. As it is, your stocks are also going up. Be very fearful of IPO’s hitting the market. Do not chase any fancies of the market. How does one know what is a fancy? Simple; what everyone is talking about, media reporting on the same, mutual funds coming out with similar schemes and IPO’s of the same sector hitting the markets. Remember the fancies of the Power and the Real Estate sectors of 2006 and 2007 boom and the IPO’s in these sectors which made the investors a lot poorer. I can see a micro finance fancy in the offing.

Frame the Choice : It will skew the buyer’s Decision

Of all the markets, the financial markets are known to possess the least amount of integrity where the only ruling ethos is how to make money from the other person. A few months back you had intermediaries selling mutual funds and they would swear by them. Then came the regulator and made drastic changes in the commission structure of mutual funds so as to benefit the investor. The intermediaries got hit and so did the sale of mutual funds. However equity markets were still attractive so the insurance companies saw this as a great opportunity to sell investment products as insurance products. Moreover insurance companies were free to give handsome commissions to intermediaries and agents at the cost of investor. These companies understood the framing affects and the perception driven market to come out with a product and an advertisement campaign brilliantly named “Guarantee of the highest NAV”. The product was framed in such a way that the investor would fall for a guarantee of the highest NAV and invest.( the catch was that it was not the highest NAV of the market but of the investor’s own portfolio). The market having risen drastically from a sensex of 8000 to 16000 had made the investors fearful. However they were still greedy to make maximum returns. There was a great opportunity to exploit this greed. Moreover the intermediaries of mutual funds would be provided a new product with fat commissions to earn. It was a perfect setting to sell inferior products to the investor.

 
 
You probably have seen the advertisements. Insurance companies offering a guarantee on the highest NAV of their ULIP scheme. ULIP funds invest in market listed securities which can be both equity and debt related. Since these schemes are long term in nature, investors invariably choose 100% equity allocations. However during the crash of 2008 investors have seen significant erosion in their investments and had become loss averse to such schemes. Thus there was an urgent need to rename such schemes.
 
Now “Assured Highest NAV” schemes have been projected as the ultimate solution to market risk. You are guaranteed the highest NAV during a certain period, or fund value whichever is higher at the end of term. What is sold to investors is the idea that the fund will be invested completely in equities and the highest returns from such an equity portfolio will be made available to them. This is not the truth.

This is how the structure works:

1. The initial investments may be 100% equity or a combination of debt and equity depending on the strategy followed by the fund manager.

2. The fund manager follows a portfolio insurance strategy that can be done by allocating funds between debt and equity – Here the fund manager sells equity as the market falls, so as to protect the downside. Unfortunately the ‘guarantee’ on highest Nav does not allow for the reverse to happen i.e. to buy equities as the market recovers. This results in sub-par returns from the Equity portfolio.

3. Money removed from the Equity portfolio is invested in debt. The proportion of debt increases steadily and soon the debt part of the portfolio will become large enough to ensure the highest NAV.

 
Let’s assume that over the next 10 years a 100% equity portfolio will deliver a 15% CAGR.  However a ‘highest NAV assured scheme’ will deliver anything between 6 to 10% CAGR during the same period.(As it is not 100% equity) If one were to deduct costs of 3 to 4% spread over the duration of the scheme the returns will still go down. Moreover one also pays for insurance (mortality charges). If one were to account for all these costs one would conclude these are  really inferior products. In fact they are inferior to even regular ULIP products because the guarantee on highest NAV is available only if you survive the term. If you die during the term, your nominees will get the prevailing value of the fund. They are inferior to even a regular debt product because of the high cost structure. Yes they serve the interest of the issuing companies and the intermediaries. 

A guaranteed NAV does not guarantee ‘equity linked’ returns. There is no way of knowing what the highest NAV would be and that NAV would probably have nothing to do with the stock market’s highest level during the same time. The so called guarantee is a marketing gimmick and is implicitly a result of the way the investment is structured i.e. with high proportion of debt. As an investor you are paying for such a guarantee, by accepting less than optimal returns.

Please evaluate your insurance needs and asset allocations before investing in any product. Understand your behavioral biases and do not allow others to exploit it. If you are greedy there is always someone to exploit that greed.

 

Budget Blues……..Why the hype????

It is surprising the way media is creating a hype of the forth coming budget. All business channels in particular are geared up for this Friday the 26th February 2010. You have posters of emminent personalities who would be giving their views on the budget. Then you have advertisement by a business newspaper “BUY, HOLD, SELL ” strategies to be passed on by the so called experts of the markets. Newspapers are meant to give news. However now they have started providing invetment advice. Is it convergence of media and finance or just plain marketing? Difficult to say in the present chaotic world where one does not know where one is going.

What is a Budget? The finance minister will lay down a road map for the economy and give an estimate of the expenditures. He would lay down the sources of income to meet these expenditures in the form of taxes. As every year the expenses would be more than the income resulting in a deficit figure. This figure would also bloat by the end of the year as has been happening every year leading to a higher deficit. The said would be justified by giving an example of the US economy whose deficit is much more than us. Thus deficit financing goes on and on.

Finance Minister’s Compulsions: Think twice before expecting the FM to act rationally. He also understands that you can not run your household expenses by not earning. Everyday you cannot be borrowing to meet your expenses. However here he has a mamoth task on hand. He represents a political party and is a part of the coalition government. Can he make rational decisions? Votes matter, lobbies matter, what coalition partners want matter, politics matter etc. His hands are tied.

Enter Self Appointed Advisors to FM: Since last week we have been hearing so much debate about what should the government do and what it should not do. Different experts from different fields give their take on what the FM should be doing. Does anyone care to understand the stark realities. You got to be in the FM shoes to understand that. So each of these advisors are speaking from their point of view with half baked knowledge. Should we be giving such talks any importance?

Enter Astrologers on the Budget day: The budget speech starts and everyone is glued to their TVs. Stock market fluctuates with proposals coming in. Its more of reaction rather than response. Can we act on mere proposals withot reading the finer prints in the budget? However experts are ready on different channels giving their expert views on a certain proposal  that will affect the industry and this results in wide fluctuations in stock prices. There is chaos as every analyst, business head, professional become astrologers trying to predict the effect of the proposals. They give judgement on what the FM should have done and not done. This chatter ends with the closing bell of the stock markets. Viewers are now more confused: one by the predictions of the astrologers and other by the fluctuations in the stock prices. They now wait for the real experts with their comments in the evening.

Enter the Genius and the Brilliant: Evening shows after the markets are reserved for the politicians form the ruling party and the opposition, the captains of industry,  stock market pundits,the bankers and the leading advertisers of the respective medias. Each one has an agenda. If excise duty on paint is increased the paint industry will cry foul. If tax on dividend is introduced the financial markets will complain. The ruling party will defend the budget proposals while the opposition will slam it. The PSU heads will hail the budget but the counterparts in the private sector may hold a different view. The diplomats would praise the budget, criticize it and at the same time sympathise with the FM. Others would blame the FM for missing an opportunity. Ultimately all are talking from their own point of view. This leaves the viewers more confused and past midnight they go to bed wondering whether the day was well spent and what did they learn?

Here are some rational thoughts:

1. The budget had some meaning when we were in a closed environment. However with the liberalization it has lost its meaning. Its only the media that has ignited the hype to increase their TRP.

2. Making investment decisions based on informantion flowing on the budget day is akin to gambling. You only make the intermediaries rich.

3. The budget proposals need to be studied in detail before one can study their impact. This takes time. Experts shooting off their comments on the budget day are misleading you. You must avoid any activity on stock markets based on such expert comments.

4. If everyone is happy with the budget then there is something to fear. Tough decisions have not been taken. It will harm the economy in the long run.

5. If people find the budget good then it will be bad for the economy. If they find it bad it will definitely be good for the economy.

The deficit need to be curtailed. If that has to be done the FM needs to take tough decisions like increasing petrol prices, doing away with subsidies, introducing more taxes, avoiding poulist schemes etc. People will not like it and the FM will need the political will and the courage to do the right things. Can coalition politics allow that? Well in short this is the answer to the question of budget being good or bad. You just spent a week hearing crap, now dont repeat the mistake on the 26th February 2010.

 

Are Investors becoming wiser?????

Its a refereshing change to see the investors not getting unduly enthused by the stream of IPO’s hitting the markets. Most of highly priced issues are being subscribed by the big Indian as well Foreign institutions for reasons best known to them. Off course this does not in any signify that they are making the right investment decisons. A right investment decision is always about buying a value at the right price. If the markets are bullish and the sentiment is high we have a host of public issues hitting the market as the management of these companies want to cash out on the boom and sell their overpriced shares to the public. Investors refrain show maturity and I am sure this is bad news for the investment bankers. Most of the current IPO’s have resulted in losses for investors on listing. Thank God investors have been spared as they acted wisely.

Now what does this signify for the markets? Investors are avoiding the IPO’s not only because they have become wiser but also because they are fearful. As long as there is fear, the markets cannot go down. Yes we may see some sort of volatility but investors need not worry about investing in good value stocks. Its only when there is greed in the markets that investors need to worry. How do you know that there is greed? Its simple; Stocks go up in musical chairs sequence, every other day you have a new story on a stock, sector performance and fancy do the rounds, there is a mad rush of IPO,s and they get oversubscribed, investors willing to pay any price for stocks, ” This time it is different” the most dangerous arguement to justify the bull run does the rounds. Well none of those things are happening just now so there no need to worry about making investment decisions.

Last year around this time the markets were down to a sensex level below 8000. Was that the right level? There was so much fear that people were just dumping stocks. Moreover due to bankruptcies we had liquidators selling stocks rather than wise investment decision makers. This led to stocks being sold at any prices. Now these abnormal times have become an anchor in the minds of people and they think that the markets have more than doubled and have become dangerous. I personally believe that the markets are not overpriced but fairly priced. Leaving aside the sensex stocks there still exists great investment opportunities.

 

The Casinos open earlier………

When two stock exchanges fight it should definitely be beneficial to the investors. However when the game is to snatch speculative volumes from each other it does not auger well for the investing community. The stock exchanges in the real sense are vehicles which promote the healthy functioning of the capital markets enabling the investor to participate in the capital formation process. However of lately with the advent of mutual funds and institutional investors the stock markets are turning in to glorified casinos with the pressure on the fund managers to perform in the short term. The investors have also no other choice but to play the markets on a short term basis and thus end up poorer. A good investor would have a long term horizon in mind and would access the markets a few times in a year. It is the traders and the speculators( which include institutions and mutual funds) which are the regulars in the market and the most important source of revenue to the stock exchanges, brokers, banks, government etc. It is assumed that the more time they are given , the more they will trade and more will be the transaction charges, taxes etc. The stock market business is very different. Experience shows that in bull markets even if the market remains open for two hours one can have phenomenal volumes while in bear markets even if the markets are opened for 24 hours one may not see any volumes. However the stock exchanges believe that keeping markets open for longer times the volumes will increase and the new bull market will start. They are all anchored to the crazy times of 2007 and  expecting that to repeat. Instead of thinking innovative ways to educate and service the genuine long term investors, they are facilitating speculation for the short term investor. It is only a question of time that we will see the markets open for 24 hours. We lack good quality leadership. This reminds me of the definition of “INSANITY” : Doing the same things over and over again and expecting different results.