Tuesday, 16 November 2010

Be wary of runaway stocks in a bull run

Be wary of runaway stocks in a bull run

The Bombay Stock Exchange (BSE) Sensitive Index (Sensex) revisiting the previous high of 20873 points could not have had a better timing, with Diwali and stocks making a perfect combination.

However, notwithstanding the festive connection, the index filled a psychological breach by erasing the damage of the great crash of 2008. Or maybe not.

I’m sorry to be the fly in the ointment, but I do think that investors should be paying more attention to what didn’t come back up rather than what did.

There are a number of stocks that haven’t made it back anywhere close to the highs that they touched in January 2008. For instance, for Reliance Communications (the worst of the lot), the Sensex is still at around 4800 points compared to January 2008.

And for anyone still hanging on to their DLF stocks, the Sensex is still at around 6400. There are a number of other stocks that have done almost as badly. Predictably, these are mostly from the telecom and the real estate/infrastructure industries.

Interestingly, at the other end of the scale, there are only a couple of Sensex stocks that have actually outstripped the index over this period.

The moral of the story is obvious: In any kind of market rally, there are always some questionable stories that get sold. It all looks fine as long as the going is good, but when the cycle reverses, many of the stocks and sectors, which looked like great bets, turn out to have been over-hyped. Some of these never come back. How long will it take for a stock like DLF to capture its previous high on an inflation-adjusted basis? A decade, maybe two decades? I wouldn’t be surprised if it never did so.

Today’s markets are characterised by a huge flood of liquidity from foreign investors and, even more importantly, the expectation that this flood of liquidity will continue. Investors will do well to remember that in the stock market, the foundation of future fortunes are laid when stock prices are down. When the bulls are raging, then more often than not, investors are laying the foundations of future losses.

In today’s market (as in January 2008), there are good stocks that are overpriced and there are bad stocks that are overpriced. There may even be some good stocks that are rightly-priced. Good luck finding them.

(The expert is CEO, Value Research)


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