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Commentary

Fear of Meltdowns and Power of Meltup’s

Yesterday, 19th October 2017 marks the 30th Anniversary of the greatest crash seen in US Markets when the Dow tumbled 22.6% (close to close). Unlike 2008 though, this barely had a impact on the real economy which continued to remained buoyant.

There is once again fear that maybe we are on the edge of something similar – a meltdown of market though unlike in 1987, its unlikely to be a one day affair. While 2008 still evokes strong memory, a risk of 2008 is even lower given that the financial markets aren’t stretched and all the fears of a looming Credit Card Bust / Housing Loan Bust / Municipal Bond Bust dragging down the markets once again seem to have disappeared from the investors and markets mind.

These days, even threats of wiping out America by┬áKim Jong-un is seen little more than empty threats and are compared to the Boy who cried Wolf once too many times. The smoothness of the rise wherein markets haven’t seen a substantial fall for quite some time is un-nerving for many but then again, a key factor that is also driving markets is the Fear of Missing Out.

While the markets recovered from the 1987 crash by just a year, the psychological impact takes much more time. As markets continue to climb the wall of disbelief, fear turns to envy and finally greed overcomes fear. The final leg of such a rise can be called a “Melt Up“.

Prior to the the final top of March 2000, Nasdaq had doubled from the starting point of 2600 seen in October 1999. Our own Nifty 50 saw a screaming rise of 50% (4000 to 6000) between mid August of 2007 to mid January of 2008. But Melt-up’s needn’t be the end of a bull market as one experienced in early 1986 in the Nikkei 225 (a case of False Positive). On the other hand, Dow in early 2008 barely showed any signals of a Melt-down.

Currently markets are expensive though not as expensive as we had seen in 2008 or 2000. Combined with the fact that FII’s are continuous sellers while the retail is lapping it up (Direct or Indirect barely makes a difference since Retail is always seen as Weak Hands) makes one wonder how long this rally can last.

The period between 1980 to 2000 was one of the greatest for a investor in the United States stock markets. Dow rose more than 10 times in the intervening period while many a stock delivered much much more. But that one event of 1987 raised fear so much that investors were caught flat footed and missed a substantial part of the rally. They did enter in force towards the end just to see entire portfolio’s, most of which were tech heavy, being wiped out in just a year and more.

Participation increased tremendously with share of households who had a stake in the markets climbing from 19% in 1983 to 49% in 1999. While it differs from state to state, it seems that the number hasn’t moved much from there since 1999

 

There are certain similarities between Indian markets of today and the US of the early 80’s chief among which is the huge rise in investing by retail folks. Mutual funds lapped up the monies as a falling interest rate and rising markets provided confirmation that the only place to invest was in the stock markets.

This has been one of the key reasons for the strong push upwards in both the prices of stocks as well as the valuations they command. Yet, we aren’t at a stage where there is a possibility of a Melt-down, a Melt-up on the other hand cannot be easily ruled out.

Melt-up’s and Melt-down’s some time have a trigger – for instance our own case of Melt-up in 2007 was triggered by the US Fed action of cutting Fed Rates by 0.50%. Or take the case of Nifty closing the day barely seconds post opening in May 2009 in the back-drop of Congress winning more seats than what the markets anticipated.

On the other side we have Melt-downs such as the fall we saw when NDA lost the 2004 election or the fall we saw in late January 2008 when in the space of just a few days, markets went from 6300 to 5200 (at the low’s).

Both Melt-up and Melt-downs generally do not happen without some iota of signalling. While we focus on 19th October 1987 as the day when the bottom gave way in the US Markets, markets were already hobbling in the day’s prior. Same was the case when the final result of the 2004 Elections came in, the markets had already started to discount NDA coming back and all it needed was a last push – something a statement from Sitaram Yechury achieved.

What next for the markets has been a million dollar question for market participants with stories of how investors are breaking fixed deposits in Banks to invest in markets. But the reality (based on data) is something else. Yes, there has been a huge interest in Mutual Funds in recent past but all the money hasn’t gone into equity alone.

Between January and September of this year, Equity Mutual Funds have seen a inflow of 86K Crores while Balanced funds have seen a inflow of 60K Crores. With most Balanced funds having a portfolio with Net Equity Exposure closer to 50%, this can provide a cushion if and when market tanks. On the other hand, this also showcases that even distributors who sell majority of the funds aren’t really comfortable at the current stage of the market and would rather push their clients to lower risk / lower reward funds than what they did in normal times.

On twitter, Experts have been foretelling doom for quite some time and yet markets continue to defy gravity. High valuations can be a factor that leads to a fall but is generally not the trigger. Markets are at all time highs and yet there is perceptible bearishness in the commentary.

While I have participated in both the 2000 rally and bust as well as the rally leading to the 2008 bust, I fail to recall the widespread skepticism I am seeing right now when the markets were peaking out then. One reason for the Skepticism could be the fact that direct investors haven’t reaped rewards as easily as they did in 2000 or 2008. In 2000, Information Techonlogy stocks was what attracted most and man, did they generate returns. Only those invested in old economy stocks were feeling left off.

The rally leading to the peak of 2008 was much more broader than the one in 2000. 8 out of 10 stocks were in strong up-trends. While Infrastructure and Real Estate were key drivers, almost every other sector was a participant in the rally that seemed to herald the start of a new era.

Friends of mine who I know as perma-bears turned to bulls unable to overcome the overall sentiment that overtook the markets. When the fall came, perma bears friends such as those suffered more burns than even perma bulls for unlike the bulls, they entered too late in the game and waited too long before cutting out their positions when the market turned for real.

One reason for the current skepticism is that this has not been a market where majority of the stocks in the market is on a uptrend. Just a week ago, more than 50% of the stocks were not even trading above their 200 day EMA, let alone be making new 52 week / all time highs.

A Whatsapp message doing the rounds credits much of the recent rise to just 2 stocks – Reliance and HDFC Bank. The story spun is that, if only these two stocks hadn’t moved so much, markets would have been negative rather than closing once again at a all time high. Sentiments are negative even though on the surface people claim to be optimistic.

Investors of today are said to be of a different breed than those of the yesteryear’s. While in US, they are moving lock, stock and barrel to cheap ETF’s and Index funds over expensive Mutual Funds, in India, the flow is said to be from Real Estate and Gold to Equity.

As much as I would love to believe that narrative, I wonder if human behavior can really change in such a short period of time. Have we suddenly grown immune to the basic desires that drive us – Greed and Fear?

Bull markets, be they in Stocks or markets in general are accompanied by good stories. Stories of how GST will make Logistics companies valuable beyond imagination drove stock prices of any company associated with the logistics business and yet by the time GST actually was implemented, most stocks are in strong bear trends [Blue Dart is down 48% from its peak, All Cargo is down 26% from its peak, GATI is down 48% from its peak, Snowman is down 63% from its peak among other notable stocks].

Look at the newspapers and you see barely any good news on the horizon let alone India Shining stories. Complications in implementation of GST is seen as dragging down growth, the demonetization coming undone has driven a spike through growth, Modi is seen as becoming defensive. And yet, we have a market at a all time high and a strong Rupee (despite the substantial withdrawal of FII money from markets). Not the things you would tend to hear during the final phase of bull market that has been for more than 3 years now.

To me, these indicate that there maybe a possibility of a melt-up rather than a melt-down which is being anticipated by most. I just don’t see the factors that would be reason enough for a melt-down in the coming days. That said, as I have written in the past, finally it all boils down to your asset allocation mix and how comfortable are you to hold the same even if market cracks say 20% from here.

I believe that I have enough dry powder to take advantage of any such fall while at the same time not risking as much that I shall be one of the sellers as the markets cracks big time rather than being the buyer.

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