Dalal Street’s perma bear warns of oversupply of paper; bullish on LIC, SBI

"My top bet is Oracle Financial Services by a wide margin," Sharad Shah said, during the interview

Sharad Shah, who has been in the stock market for over four decades now, prefers to make his trading profits by short selling. He is a man of few words, but does not mince them.  His strategy is two-fold: build a portfolio of good quality shares for the long term and go after companies with shaky fundamentals trading at high valuations.

His unorthodox approach draws a lot of criticism, and even ridicule, particularly when he maintains his bearish stance in a bull market like the ongoing one. Shah is unfazed.

“The fact that a stock like Jet Airways without any operations is trading at Rs 50 tells you how irrational the market has become,” he said in a freewheeling chat with Moneycontrol.

He discussed the reasons for his bearish view, the stocks he is bullish on, his bearish bets, why private sector banks could fall sharply from these levels, and why FIIs should be allowed more leeway to short sell.

Edited excerpts

You've been bearish for a while now. But the market has been rising. Have you changed your view?

Absolutely not. And as for my bearish trades, there are plenty of opportunities in the market. And I don't do trade the indices at all. I don't play Nifty Bank (index).

You must be playing it through the F&O (futures and options) route, right?

Yeah, only F&O.

But the market has been in an uptrend. So that must be hurting?

No, because in F&O (stocks) also, on any given day, out of 185 stocks, 30-40 are down. And some of them are structurally very weak. So those are happy hunting grounds for me. And the options (of those stocks) are often juicy. Whenever I see they are mispriced (higher than fair value), I sell them. Or I buy them if they are mispriced (going cheap) on the other side.

Do you short sell the same set of stocks or does the list vary a lot?

Generally, they are the same only…most of them. And it would not be prudent for me to name the stocks because it will work against me.

Where does your big money come from? Your investment portfolio or trading bets?

Of course my long term portfolio. Trading is only time pass. You cannot make serious money from it.

Any trading rules that you always stick to?

When in doubt get out.

Can you quantify that, like typically at what point do you feel your trade may not be working out?

It is too complicated. Forget it.

Tell us about your investment portfolio?

It is in a trust where I can’t take a decision to sell. I can if I want to, but it is a complex process. I cannot reduce my holdings to zero. The dividends have to be reinvested, and all that. And I have done it because it's an irrevocable trust. No government on earth can touch it. And I have had plenty of issues earlier. So, I did it.

I am guessing you are referring to your run-ins with promoters whose stocks you had short sold in the past.  Does that still happen?

No, I am past that. Besides, the promoters are too big. Each one is 50,60,70 thousand crore (market cap). No point messing with powerful people. I don’t have the funds for that. But eventually, next year, when everything comes down to their true value, then we'll see. Because next year, I think all the bubbles will be out.

In other words, you are saying this rally will run for another one year?

No, it will take one year to take the air out of the bubbles. I'll give an example of Rajesh Exports. I realised in 2006 that its numbers (financials) did not add up, and used to short sell it heavily. In 2009, the stock was taken out of the F&O list. And now all the problems in the company are out in the open. It took the market 15 years to realise that. So things don’t happen that fast.

The fact that a stock like Jet Airways without any operations is trading at Rs 50 tells you how irrational the market has become. Even in fundamentally sound companies, there is a lot of froth. One has to be careful.

What are the red flags that you are spotting?

Five months ago, the open interest in stock futures was Rs 1.9 trillion (Rs 1,90,000 crore). Now it is at Rs 3.48 trillion. So you can imagine the kind of leverage that is there in the system.

But the margining system is far more stringent than it was in the past. Isn’t it. Brokers are collecting margins on time.

Margins are being collected on time, no doubt. But that will not good enough in the event of a panic. If prices fall 20-30 percent suddenly and people are not in a position to put up additional margins, their positions will get liquidated. Right now, because this is a rising market, people are ignoring the risks.

You sound like a prophet of doom

No I am not trying to scare anybody. All I am saying is that the situation is grim, but people are not realising that. There is simply too much paper (shares) coming into the market because of companies raising funds.

But domestic inflows are strong, there is lot of money coming in through mutual fund SIPs.

Not enough to absorb the massive supply (of shares). SIP inflow is around Rs 18,000 crore a month, while everyday few thousand crore of paper is coming into the market.

The more alarming thing to me is the build up open interest in stock futures. It will take a heavy toll on the market at some point.

What is the solution for the second part, about the outstanding futures positions?

SEBI had put restrictions on short selling during COVID. Nifty was 8000 then, it is 22,000 today. It makes sense to ease the curbs. Give FIIs more freedom to short sell.

They (FIIs)  can even now, right?

No, they can only hedge. If they have Rs 100 worth of shares, they can short Rs 100 worth of stock futures.

They can always short through the SLB (securities lending and borrowing) route, can’t they?

That’s not an efficient route. That is evident from the low volumes in that window, beyond a few stocks

You are suggesting that FIIs be allowed to sell naked?

Yes. If you welcome FII money, then allow them to short sell too.

Given the muscle power of foreign investors, they could use that to hammer the market. Is that not a risk?

Why would they do that?  They want to make money too. That is not possible by hammering the prices all the time. Also, if you do not have short sellers, there will be no fair price discovery.  This is a kind of long only market right now. Mark my words, private sector banks. HDFC Bank and all other private sector banks can go down by 50 percent from current prices.

What makes you so confident?

Internationally, the PE (price to earning) ratios of big banks are 8, 9, 10 maybe. In India, it's 19, 20, 25. This cannot sustain. Sooner or later, it must come down to global standards.

But aren’t banks valued on a price-to-book (value) basis? HDFC Bank is less than 3 times book, SBI is less than 2 times book…

I did not mention SBI. I said private banks. No, I don't know what the price to book is. I know the PE ratio for HDFC Bank is 19.  And let me have the liberty to calculate value the way I want to.

How is the market looking to you?

Tired. Horribly tired. The advances to declines ratio are clearly indicating that. Some of the big foreign players and even local ones are whispering a 2000-3000 point fall.

But majority of the reports by foreign brokers paint a bullish picture. A few days back Jefferies made a strong case about why foreign funds will be forced to buy Indian equities or risk underperformance?

I said fund houses are whispering. They will not talk about a correction openly. But if you happen to know them well enough and talk to them in private, their views will be different from their public ones.

What do you make of the frenzy in small and mid caps? And the fact that HNIs have become a powerful class of investors because of the money they have made post-COVID?

Much of it is on paper. Unless you are able to cash it, what is the point. You will have to sell at some point to be able to realise the profit. And I strongly believe in reversion to mean. Majority of the stocks that have risen sharply are not backed by fundamentals. They will go back to from where they started. Because prices have risen so much, there are not many more fools left to sell your stocks to. Whom will you dump the stocks on?

But there is a lot of liquidity in the system. You can’t deny that

Agree. The problem with your argument is that if money were the only factor, there would have been no bear market ever. There is always liquidity in a bull market. But the market moves on crowd psychology, not just liquidity. And it does not take much time for the mood to change. We have seen that in 2001 and in 2008.

What are the stocks you are bullish on?

My top bet is Oracle Financial Services by a wide margin. Then there are Cummins India, Alkem, Castrol, Bajaj Auto, Castrol, Bosch.

Since you have spoken about your bullish bets, you might as well spell out your bearish bets, besides private sector banks?

Whole host of PSU stocks, specifically those that have run up sharply in the last 2-3 months. SBI and LIC are exceptions. SBI, I think has the potential to go to Rs 1200. LIC, I am bullish on because in the smaller cities, people still prefer to go to LIC for taking out an insurance policy.

Anything else you are bearish on?

Some of the high flyers.

Like?

Polycab, SRF, Navin Fluorine. These stocks will come down to triple digits in 2-3 years.

Which have your profitable short selling bets been over the last year?

AU Small Finance Bank, HDFC Bank, Navin Fluorine.

Which stocks cost you money?

PSU stocks.

How do you identify stocks to short sell?

I look for companies with high debt and high receivables.  If the stock price has run up sharply and then stayed flat for a while, I see that as an opportunity. Sometimes the wait can be quite long, and it does not always pay off because the promoter can support the price.

Do you hedge your positions?

Yes, one has to. Both to protect the downside as well to reduce margin obligations. When I short futures, I also write or buy options.

You mentioned the huge open interest in stock futures. But a lot of that positions would be hedged, no? 

No. Because most people don’t understand derivatives. Especially the new entrants. And because prices have been rising for a long, they have become over confident and don’t feel the need to hedge.

But my advice to people is: don’t copy my strategy. This is a mad market. If you are not familiar with short selling and try to do it, you can get wiped out overnight.

How does it feel to be called a bear?

I don’t see myself as a bear. I call myself an opportunist. You can’t survive otherwise.

Do you go long as well in stock futures?

Occasionally yes. But mostly in MNC and IT names.

Do you read balance sheets before you invest in a company?

Yes, but just a one page summary.

One of the running jokes about you is that the only bear market is in the Twitter Spaces hosted by Sharad Shah every Friday evening. How do you respond to that?

I am not bothered.

But your opinions draw a lot of ridicule on social media. Does that affect you?

If it is coming from a person who has been in the market long enough, I will listen to what he has to say. Why should I care about random kids who have not even seen one full market cycle.  Even otherwise, age makes you indifferent to a lot of things. I am 66. I have developed a thick skin over the years.

It is said that bear traders are few because humans by nature are optimists. Are you gloomy by nature in general? Is that why you enjoy short selling?

You are mistaken. Going after stocks that don’t deserve the valuation they trade at, is not being gloomy. I am definitely not that. I am in fact quite jovial and a party animal by nature.