'New sectors will have to emerge for another bull run'

Q: What causes a bull market to start?

Riddham Desai: Firstly, liquidity and second thing is valuations. So valuations get really attractive. There is a lot of fear in the market place, market participants are not interested because they think that stock prices are going to fall further because earnings estimates are going to fall further and we get to a point where they say stocks are trading at six-seven times earnings — big deal — they are going to trade at three times and then there is a infusion of liquidity, which comes out of the macro cycle. That is very normal because growth has slowed down and there is excess liquidity in the system. This combination then leads to the first rally in stock prices and then as these rallies build up, confidence grows, growth forecast improves, the economy improves and then ultimately you get a raging bull market.

Q: How would the fact that you also need a technological change or productivity change, is it enough just that valuations are cheap? Cannot they remain cheap?

Desai: You need a fundamental change and that is quite important to the market. Every bull market is accompanied by change in fundamentals, whether that is a change in technology or in the growth outlook of an economy because of demographic change — whatever that change is — that fundamental change is important otherwise it peters out and proves to be a bear market rally. So you get these three things going together and I think that is how a bull market gets created.

Q: You have studied bull markets, you have studied yearly analysis; in your opinion what is it that lights the match?

Raamdeo Agrawal: The first fundamental thing is there should be enough pessimism to lay the foundation for the bull market. The pessimism, which leads to irrationally low valuations, is the starting point of a bull market. For example in 2002-2003, after the dotcom bust after two years of sustained bear market — almost third year of bear market which is a history in itself — valuations were crazy. The whole market was available at 7-8 P/E multiple, Reliance was at 6-7 times P/E multiples and there were no takers for Reliance. The market itself was at 1.5 times book. Pessimism was all over and there was a belief that nothing could happen. Back then, I wished that out of the 40 stocks in my portfolio, two-three must reach a new. And it was a dream — in the next 24 months, we saw half the market was in a new high.

Q: Abject pessimism?

Agrawal: Absolute pessimism is the foundation of a bull market.

Q: How important is liquidity? Is liquidity the mother’s milk of a bull market?

Agrawal: Yes, definitely liquidity is a starting point because you need money to buy stocks. Liquidity is very important, I have been ignoring liquidity as a propellant for the markets to move but it is important. In 2008, we saw margins of safety to be negative at the peak of the market but liquidity was huge, all over the world — a USD 1 billion cheque was a small thing for inflow into India and again in January 2009, it was the other way round. You couldn’t even get USD 10 million.

Q: GE also couldn't raise money.

Agrawal: Yes, GE couldn’t raise money and that too even for an ultra mega power project (UMPP), you can't get USD 100 million credit.

Q: Liquidity itself cannot assure a bull market? That would be a bubble right?

Desai: Absolutely. It is a combination, you need all factors in place and fundamentals tend to decide how long and how much the bull market will run. Liquidity provides that fire to drive it. So at the start of the bull market, liquidity is important. Very few bull markets start without good liquidity conditions. Liquidity tends to be a corollary to a bear market, which is that once growth slows down, money supply does not shrink as much as growth shrinks. So there is always that excess money stock in the market and that is how central banks and government try to work around a recession.

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