Junk index signals exuberance, chemical stocks may fall more: Molecule’s Parikh

Capital goods stocks a 50:50 bet, watch price action closely, says this PMS fund manager

Two indicators are telling Nirav Parikh that there is exuberance in the market, and one  needs to be cautious. The 42-year-old co-founder of Surat-based PMS firm Molecule Ventures has been managing investments for over a decade now, initially for friends and family, and later for paying clients. The firm today manages around Rs 450 crore for a little over 200 clients since it got a Sebi registration in May 2021.

Here's the excerpts from a freewheeling conversation:

Warning signs

The quantity of shares is a good indicator of knowing whether the market is overbought or oversold.

In January 2018, at the peak of the (mid and small cap) rally, the average daily shares traded was 46 crore. It fell to 20-25 crore during the bear market of 2019. During the Covid rally, it climbed a high of 100 crore in January 2022 as the market topped out temporarily. After consolidating between January 2022 and Match 2023, the number has been steadily rising and now stands at 145 crore.

Junk index

This volume needs to be viewed in the context of the kind of shares that are rising. We have internally come up with what we call a junk index. It has around 85 stocks with corporate governance issues, and which only participate in the fag-end of the bull market. In March (2023), around 10 percent of the stocks (in junk index) were rising. That number rose to around 40 percent by August. Today 100 percent of the basket is participating.

Bearish on chemicals

We were able to spot the chemical upcycle early in 2013 when companies across the board were expanding their capacities. Two things helped us make the decision. One, the capex was not being funded through equity dilution. Two, even if we were wrong in our call, the downside was limited because the stocks were available at cheap price-to-earnings multiples.

What has changed 

The way it works for any sector is that the leader in the previous cycle will not participate in the subsequent cycle.

One, the fundamental triggers would have played out to perfection, and the market would have priced these stocks fully. That is an important factor because the price you buy at will decide the returns you make.

Also, a lot of OK kind of companies would have participated in the previous cycle, and many people would have got stuck when the cycle peaked. Say, you have 100 stocks in the chemicals sector. The main traction will happen in, let's say, 10, 15 stocks. That will be in line with a normal market scenario. So, they'll have earnings growth, normal multiples, and returns too will be normal. But because you have too many people owning the shares, every bounce will get sold into. It is the ownership that decides the extent of the move on either sides.

Another thing that is different in this chemical cycle is that companies have lined up huge expansion plans, but this time a lot of funding is taking place through equity dilution.