May 30, 2020
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The Chill Factor

The reason for the bloodbath: the Sensex is skating away on the thin ICE of the new economy

The Chill Factor

If you said the stockmarkets were skating on ice last week, you wouldn't be far off the mark. Except that the ice (the popular acronym for infotech, communication, and entertainment stocks) was certainly not thin-on an average, these stocks have risen by a record 500 per cent in the past six months. Yet, why were the astronomical gains wiped out in a few trading sessions? So drastically that punters had to send an sos to the 'outdated' Hindustan Lever to prop up the sagging benchmark, which closed a shade above 5000 on March 16?

There was widespread selling in the ice stocks alright. And the tech-heavy NASDAQ, where biotech scrips are bleeding, went on a downward spiral. But the frantic selling on the BSE wasn't just a post-budget whack. There are certain other aspects that triggered the market slide.

ice stocks are inherently volatile. Reasons: these are stocks with a low equity base and even lower public holding (floating stock). The average equity capital of these companies is around Rs 20 crore and the public holding in them in most cases would not be more than 20 per cent of that amount. Meaning that supply is far less than the demand.

This makes many of these stocks prone to manipulation by operators, primarily brokers, sometimes even in unison with fund managers and promoters of these companies. Once the stock price is on its way up, more investors are attracted and it becomes a typical case of lots of money chasing a few stocks. Wary investors today are more eager to know whether there is an element of operator interest in a stock rather than the underlying fundamentals of the company.

Operators too have their own cartels. Only recently, it was the bull cartel driving up the ice prices. The bear cartel in turn had gone short (selling shares only to buy them later at much lower prices) on these stocks in order to divert attention towards the old economy papers, which they were holding in large quantities. Over the last six months, the bulls had completely trapped the bears. On one side they ensured that the ice stocks maintained the momentum by pumping more money into them and on the other they hammered the old economy stocks.

The market grapevine has it that a truce was finally signed between the two some 10 days ago to enable the bear operators clear their positions. Result: fresh buying ceased in the ice stocks. A small sell-off was triggered in some ice counters and that was enough to put retail investors looking for high short-term gains in a panic. Frenzy followed. The bear operators on the bourses covered their position and also benefited from the shift from ice stocks to more traditional sectors like pharmaceuticals, fast moving consumer goods (FMCG) and select commodity stocks.

There is also the argument that these stocks had become overvalued whereas the old economy stocks in the commodity, industrial and the FMCG sectors were going a-begging. The market had clearly become lopsided with only the ice stocks hogging the limelight. Also, the ice stocks have a strong correlation with NASDAQ, which has been falling sharply-losing around 10 per cent in the last five trading sessions since it closed above the 5000 mark for the first time. It was clearly time for a correction.

The bottomline is: these stocks will continue to be volatile because of the high speculative interest in them. They would invariably tend to fall and rise in a higher proportion vis-a-vis the overall market. A cursory glance at the prices of major ice papers and the movement of the BSE benchmark over the past six months clearly bears this out.

For investors, then, it's time for a fresh look at their investment strategy. But then you wouldn't be one if you are looking for big gains in the shortest possible period. And even if you want to punt, you'd require nerves of steel swinging between the operators and the NASDAQ. But if you're an investor with a pretty packet of ice papers, staying put in these turbulent times and not being rattled is the key to long-term returns.

At the same time, you shouldn't succumb to the ice wave. No doubt the new economy has a perceptible advantage over the old, but the latter is catching up and readying itself to exploit this new medium, the Internet, to improve efficiency and profitability. Consider a few numbers. The combined revenue of the ice companies is around Rs 10,000 crore, close to what a single company like Hindustan Lever clocked in the year 1999. The same scene in terms of net profit: Rs 1,300 crore for the ice companies and around Rs 1,070 crore for hll. But the total market capitalisation of the former is a staggering Rs 4,20,000 crore-seven times that of hll!

Is such a mind-boggling premium justified for the ice stocks? Why not, considering these companies' superlative growth record? More pertinent would be to ask whether this premium is sustainable. Until now, it's been smooth sailing but henceforth the stakes are going to be upped with every ensuing quarterly results. Do keep your fingers crossed.

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