Buy-buy months
The first half of a year tends to have a deceptive bullish bias and investors have to be on their guard
The first half of a calendar year is critical for stock investors as it tends to have a bullish bias. Often that is a trap for trend-sniffers and quick-buck seekers.
By a recent report, around 90 per cent brokerage recommendations to their clients globally is buy recommendations, 4 percent is hold advice and only 6 per cent is sell recos. That is as rosy as it can get. Consider this, a recent technical research report by a large domestic brokerage, which is part of a large private bank, stated that on technical parameters, 48 out of the 50 Nifty stocks are either structurally in outperformance and in the bullish mode or on the verge of getting into a bullish mode.
If one were to go by this report, in the next 12 months, one can take long trade with gay abandon and there is no question of the Nifty correcting. In all probability, that will not be the case. The Nifty will have phases of ups and downs and long trades will give both returns and losses. The trouble with all these reports is that brokerages have a bias towards buying, for a reason. That is, if a buy recommendation goes wrong, the target price can be adjusted against the holding period as the holding period can be easily extended from six months to one year. But this bias hurts retail investors the most. While they get plenty of buy advice, they seldom get an advice on when to sell. The hard fact is that in equity investment, when to sell is more important than when to buy. For example, all those investors who did not sell their IT stocks in 2000 and infrastructure stocks in 2007 have never recovered their investment, forget making inflation adjusted returns. The trouble get compounded for retail investors when recos are on small-cap and mid-cap segments. In these segments, sell recommendations are rare.
As another year begins, it is important for investors to know the character of the first half. Usually, the January-June period sees the maximum number of buy reports. This trend has got established over a period sincemost foreign funds allocate money for emerging markets in first three-four months of a year. In order to attract that money, brokerages come out with buy recommendations, often in consultation with company managements. It is these inflows that tend to keep small and mid-cap stocks buzzing in most cases.
Notice that in the last two weeks, after remaining under pressure for four months, suddenly life has returned to small- and mid-cap segments. In the last few days, the market breadth of small- and mid-cap segments has improved, even on days the Nifty has stayed passive.
Like in previous years, this year, too, retail investors won’t be getting any sell advice from either his broker or investment advisor. Even the best of fund managers won’t, honestly, tell you to sell equity.
So investors will have to set their own parameters to decide when to sell. But most parameters are non-numerical in nature and investors have to make efforts to construct and reach a conclusion.
About the numerical parameters, the most reliable is the mid-cap segment’s market breadth. When mid-cap stocks are about to peak, there is a sudden spurt in the market breadth of small-cap stocks; many obscure stocks start to gain more than 10 per cent in a single trading session. This rocketing move tends to last for 10 to 12 trading sessions, during which every day a new set of small stocks makes it to the list of top gainers. As this is happening, the momentum in good quality mid-cap stocks tend to stagnate or lose marginally on most trading sessions.
After a short period of plateauing, the mid-cap segment breadth start to decline gradually. And then comes a market shock that normally hits the main index and the mid-cap segment together. Then mid-cap breadth suddenly turns bad and mid-cap stocks decline sharply, sometime losing all the weight they have gained in a month in one single session.
Now the question is from where does an investor get the data for market breadth. While a few newspapers occasionally carry this data, stock exchange websites do have this data, which can be seen in the details of individual indices. Also, check if divergence is seen in the market breadth of two large indices. For example, divergence in the market breadth of BSE 500 and BSE 200 gives a good indication on what is happening in the underlying market; whether smart money is moving out of mid-cap stocks or moving into them.
The most reliable non-numerical parameter is analysis of news about a firm or sector appearing in the print or visual media. When news about a company or a sector becomes overly positive, it is time to be cautious. To illustrate, go back by four months; stocks of micro finance companies were then flying high. Company managements gave rosy guidance on how they were moving on track to capture market share and expand in new states. Analyst reports justifying sky-high price-earning multiples were being pushed out from every large broking house. TV channels were at the forefront of getting these analysts to their studios. See what happened to these stocks today; they have corrected 40 to 50 per cent from their highs of early September.
It is not just the MFI sector, go back in time by a year, consumption stocks were being touted as the biggest investment theme then. See where are they today. One common feature at the peak of a mid-cap bull run is that justification of valuation becomes the main theme of media discussions. When that happens, it is time to be cautious and book profit.
Another parameter to look at is the amount of money being raised through qualified institutional placement by large- and mid-cap companies. In the past many instances, the peak of mid-cap stocks had happened with a boom in the IPO market. Today, perhaps, the initial public offering market is not the most reliable indicator of greed on the Street. It is rather the qualified institutional placement (QIP) numbers which would better indicate the time to book profit. When QIP activity increases, it indicates two things are happening. First, money which otherwise would have come to the secondary market is flowing somewhere else and that is surely not a good thing for the secondary market. Second, a heightened activity in the QIP market indicates that the whole exercise companies had been doing with their investment bankers for months is coming to a conclusion.
That is, all the positive news flows created for the consumption of QIPs and that gradually pushed up the stock price, has come to a (il)logical end. Once that is accomplished, the brokerages have no need to do expensive market making exercises. In three of the last seven years, the market’s peak has been accompanied by a peak in QIP activity.
So, next time when bulletin boards of stock exchanges are filled with announcements of intention of QIPs or successful QIPs, think twice before getting bullish. Remember, buying a stock is the easiest thing to do. But learning the art of selling is something one needs to hone with dedication and prudence.
(Rajiv Nagpal is consulting editor, Financial Chronicle)
Rajiv Nagpal