BackPredicting the next new thing in markets
Investing in stocks based on their 'winning' performance in a previous bull run makes for a poor choice
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It is said history doesn’t repeat itself, but it rhymes. It is worth looking at the previous boom-bust cycles in the Indian stock market to discuss whether the winners of the previous bull market are able to repeat their performance in the next.
This debate is especially relevant at this time because the Indian market, after a long hiatus of more than six years, seems to now have conclusively crossed the previous high. There is growing excitement that we might be at the cusp of the next bull market.
The euphoria is undoubtedly centred around the strong mandate that has marked the general election. Moreover, 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 the stocks in their portfolios that are under-performing the market.
One of the common reasons for this to happen is the tendency of investors to look at the big winners of the previous bull market and to assume that they will 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 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, proving to be merely a mean reversion trap. 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 technology sector in the year 2000. After the bubble burst in March 2000 tech stocks took a severe beating. However there was a 50%-plus “echo" rally from the lows in May-June of 2000 that created the illusion that tech stocks could stage a comeback. The common argument heard then was that the dot-com meltdown affected Internet companies in the developed markets that relied only on eyeballs and had no real business models, whereas the Indian tech sector had solid fundamentals led by the need for low- cost outsourcing. While that might have been true, clearly at price-earning multiples in the range of 100x, the stocks were building in a growth trajectory that could not be sustained.
Similar was the case in the infrastructure-led bull run of 2003-07. The market capitalization of stocks in BSE500 Index that could be identified to the infrastructure theme rose about 32 times from April 2003 to December 2007. This was aided by more than 50 stocks from engineering, real estate and infrastructure-related sectors that were added to the index during that period.
It is usually common to see stock additions in sectors that are the leaders in a bull run. However, the sector has lost its sheen over the last six years, despite many false starts. Again, a common refrain we hear from investors is that India is an infrastructure deficit country and this sector has to see a resurgence in the stock markets. While the importance of the sector from the viewpoint of the Indian economy is probably right, it remains a fact that the 2003-07 period saw these companies earn super-normal profits, often because of crony capitalism. And that is unlikely to repeat itself.
It is almost impossible to predict where the “next new thing" could emerge from. However, the common traits that we notice in the “next new thing" in the markets are few listed stocks to begin with, low research analyst coverage and low representation in the index. Gazing into the crystal ball we can only guess what could be the emerging trends in the next bull market.
Deals in the private equity space could be an instructive guide. Some areas that could see interest going forward could be e-commerce, transport and logistics, branded consumer products and a shift from the unorganized sector to the organized sector. Or maybe it could be none of the above. After all, as American businessman and investor, Mark Cuban once said: “if you’re looking for the next big thing and you’re looking where everyone else is, you’re looking in the wrong place".
Amay Hattangadi and Swanand Kelkar are portfolio managers with Morgan Stanley Investment Management. These are their personal views.
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