Moneycontrol Pro Weekender | Dizzying Heights

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Dear Reader,

The conquering of Mt 80000 this week has understandably brought some angst, so much so that even the country’s Chief Justice has thought it fit to call for caution. The markets shrugged off his words on Friday. SEBI, on its part, has decided to cool the red-hot SME IPO market by stipulating a cap of 90 percent over the issue price for such IPOs during the special pre-open session. No punch bowls removed here, it’s like trying to curb alcoholism by having one dry day in a week.

While we’re all enjoying the wild party, it is human nature to wonder why. As the novelist Kurt Vonnegut put it: “Tiger got to hunt, bird got to fly; Man got to sit and wonder 'why, why, why?”

One simple explanation, as a strategy note by Kotak Institutional Equities says, is “increasing faith in narratives and myths and declining focus on numbers and facts’’. Our Decoding Economics column this week was on the power of narratives and gave us an opportunity to quote the existentialist philosopher Jean-Paul Sartre: “A man is always a teller of tales, he lives surrounded by his stories and the stories of others, he sees everything that happens to him through them; and he tries to live his life as if he were recounting it.”

But enough of the philosophy. The Indian markets are not the first nor will they be the last to see retail frenzy. An article in Korea Times last December had the headline ‘Theme-driven stock frenzy dominates Korean market in 2023’. The Chosun Daily had this lovely story: "Shares in South Korean food conglomerate Daesang Group have soared since ‘Squid Game’ actor Lee Jung-jae and Justice Minister Han Dong-hoon, a potential presidential candidate, were spotted dining together at a restaurant in Seoul in late November. The firm’s preferred stocks, Daesang Holdings Pref, surged 525 percent in nine days to become the biggest gainer in the Korean stock market. Lee has been in a relationship with Daesang Holdings Vice-Chairman and majority shareholder Lim Sae-ryung for nine years.’’ A Bloomberg story in 2021 had this headline: ‘Retail Frenzy Lifts Three of Asia’s Top-Performing Stock Markets -- Individual traders play huge role in Vietnam, Taiwan and Korea’. Well, Vietnam’s VN Index is lower now than where it was back in early 2022 and the Kospi is lower than where it was in mid-2021. Taiwan is at new highs, but that’s due to another frenzy -- semiconductors.

Nor are such trends recent. Back in 1841 the Scottish journalist Charles Mackay published a book titled ‘Extraordinary Popular Delusions and the Madness of Crowds’, which contained the memorable line, “Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”

Back home, foreign portfolio investors now seem to have joined the herd.

But how much do flows matter? The Kotak report points out that “the net amount of ‘money’ is always zero in the secondary market (somebody will buy, somebody will sell) at all times and at all price points’’ and that “mutual fund flows have no predictive power over forward returns, but are a function of trailing returns’’. That view has academic support from a New York Fed research paper on ‘Market Returns and Mutual Fund Flows’ which says that investor sentiment may be driving both flows and returns and an optimistic sentiment may encourage investment in mutual funds at the same time that it pushes up asset prices. This paper from the Bank of Korea says their findings do not support the popular notion that considers mutual fund flows as a driving force behind rallies in Korean financial markets.

But, as usual in the social sciences, there are research papers that say the exact opposite. A 2022 paper by researchers from Harvard and Chicago Universities says, “Economists often appeal to the truism that “for every buyer there is a seller” to disregard the notion that a measurable increase in the willingness of the average trader to buy more of the market will push prices up (“buying pressure”). Our model clarifies that this reasoning is incorrect.’’ Readers eager to disprove their thesis can look at the algebra on which their model is based here.

Perhaps the common-sense view is as Benjamin Graham said, “In the short run, the market is a voting machine but in the long run, it is a weighing machine.’’ Flows matter in the short run, but in the long run fundamentals are more important.

That is all fine, but much depends on how short the short run is. JPMorgan chief strategist Marko Kolanovic lost his job recently after being bearish on the US market since early 2023. Why, even the Bank for International Settlements abandoned its role as Cassandra to tell us that its base case was a smooth landing for the global economy, before force of habit made it list all the things that could go wrong. Kolanovic must be pondering Keynes’ advice: “The market can stay irrational longer than you can stay solvent.”

To be sure, with valuations where they are, it may not take much for investors to be disappointed. The June quarter corporate results could act as a catalyst -- a Kotak Institutional Equities note says they expect Q1 FY25 net profits of the BSE-30 Index to increase 8.1 percent year-on-year, but decline 8.4 percent quarter-on-quarter and for the Nifty-50 Index to be flat yoy but decline 10.7 percent qoq. We pointed out that the Q1 business updates from banks are not music to investors’ ears. We expressed our discomfort with the rich valuation of the Emcure IPO and asked investors to keep Bansal Wire Industries “on their radar for a better entry point”. We wrote that the increasing number of promoter sales in smaller companies is a warning sign.

On the other hand, though, what with the Union Budget coming up (do see our Budget stories linked below), a decent monsoon, stronger exports and rate cuts down the road, momentum may well be sustained. Who knows, maybe we’ll have another Roaring Twenties, with a 21st century Gatsby believing in “the orgastic future that year by year recedes before us. It eluded us then, but that's no matter—tomorrow we will run faster, stretch out our arms farther.’’

Should investors then start running faster? As Larissa Fernand says, don’t get nervous at market heights, focus on what you’re buying. Kenny Rogers sang it for us:

‘’If you're gonna play the game, boy

You gotta learn to play it right

You've got to know when to hold 'em

Know when to fold 'em

Know when to walk away

And know when to run’’

Cheers,

Manas Chakravarty

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