Are bubbles all bad? - Straight from the Hip by J Mulraj
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Investing in India - Straight from the Hip by J Mulraj
Are bubbles all bad? A  A  A

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13 MARCH 2010


A few months ago, the alumni association of the Asian Institute of Management organised a panel discussion on the topic 'Are bubbles all bad?' The panel was a wonderful mix of people, an academician, a politician, an entrepreneur, a market player and a columnist/researcher. Other than the market player, who made a feeble attempt at defending bubbles as a market phenomenon, the consensus was that bubbles were the next worse thing after the snake at the Garden of Eden who tempted Adam to take a bite of the proverbial apple.

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For investors, one of the main causes of concern right now is whether the excess liquidity pumped in by the US Fed and by other countries to stimulate their economies are resulting in bubbles which may burst. With almost all Q4 results out in the US, the P/E ratio, at 22, is at the upper end of the P/E band. Global stockmarkets have zoomed significantly from their lows. But there is danger! According to Stephen Roach of Morgan Stanley, the estimated 'toxic assets' with banks amounted to $ 3.4 trillion, of which only half has so far been written off. These were assets acquired by asses during bubble years in a triumph of greed over prudence.

Whilst all bubbles are bad, bubbles are not all bad. They do leave some beneficial legacies behind, sometimes. To misquote Shakespeare, 'the evils that bubbles do live on after them; the good is oft interred with their bones'. After World War II, a stock market bubble was created in India, thanks to the enormous liquidity in a few hands which had supplied the war effort. This liquidity needed investing opportunities and, although the BSE was one of the oldest exchanges in the world, the universe of stocks to invest in was small. It comprised mainly of unexciting British banks. In stepped a broker by the name of Premchand Roychand, who seized the opportunity provided by the liquidity to float several companies, one of which was called The Backbay Reclamation Company. Efforts to reclaim land would have been hugely delayed were it not for the bubble! Similarly, it was during bubble years that 2 companies got huge funds to lay undersea cables; though the companies went bankrupt and were bought out by Tata Communication and by Reliance Comm., at some 10 cents to the $, the assets financed by the bubble are a legacy of it and help in providing cheap telephony to IT and other industries.

Bubbles are, however, inevitable, a fact that investors (as also policy makers) ought to realise so that they could shape their actions in accordance, instead of lamenting the creation of them. This is because of the four factors of production, viz. men, material, machinery and money, it is only money that is capable of being digitized. This gives it the ability to move instantly, at the click of a mouse. Moving material takes a few days/weeks, machinery a few weeks/months and men a few months/years (in terms of immigration). The increased velocity of money, compared to other factors of production, would, naturally, increase its weightage. That's why the share of financial companies in GDP has been steadily increasing, markedly so since the '80s.

It was in the '80s that the US, in a bid to counter the economic successes of Japan and Germany, which had adopted 'stakeholder' capitalism, started focussing on 'shareholder' capitalism. In the '80s Japan was a roaring success. Seven of the top 10 banks in the world were Japanese. The most valuable stock in the world was NTT DoCoMo. The Japanese were buying American icons like Universal Studios and Rockefeller Centre. The Nikkei index hit a stratospheric 38915 in Dec 1989 (and has gone into a 20 year decline since).

The American response was to promote shareholder capitalism, in which interests of shareholders (i.e. providers of money) are of primacy, with interests of other stakeholders falling in line. One of the pillars was the institutionalisation of money, through the fund industry (mutual, pension, hedge et al). This worked! The % of corporate equity in individual hands has fallen from over 2/3rds to under 1/3rd in the past 4 decades since mutual funds made their foray. The % in institutional hands has, correspondingly, risen. Before the financial crisis, the two largest institutions each had assets under management exceeding $ 2 trillion, or twice India's GDP. This institutionalisation of money, combined with the principle of greed underlying shareholder capitalism, and combined with the attribute of digitisation of money, inevitably results in the formation of periodic bubbles.

Individual investors, realising the inevitability of bubbles, ought to set for themselves happiness targets for return when buying a stock. (I would be happy if the stock gave me a ___% return). When the return target is hit, a quick review to see if there was still a lot of upside, else sell, would be a practical policy to follow. After all, one's enjoyment of a buffet is not marred by the bigger appetite of one's friend.

So yes, there are concerns of excess global liquidity creating bubbles and yes, there are fears of toxic assets being unearthed and causing shocks. Yet the India story remains good, marred only by the inanities of public governance, with little thought of nation building. The unedifying spectacle of upper house Parliamentarians misbehaving whilst opposing the Women's Reservation Bill purely on vote bank politics, is the latest case in point.

In corporate news of interest, the BSNL Board has agreed to the recommendation by the Pitroda committee to divest a 30% stake, but the employees haven't. Another recommendation of the committee was to outsource its network operations, as has been done by Bharti Airtel, which would mean a significant downsizing of its large workforce.

The divestment of stock in NMDC has not found favour with retail investors, who find the minimum price of Rs 300 expensive. It translates to a forward P/E of around 46, compared to, say Rio Tinto, of 9, and 12 for BHP Billiton, according to Economic Times. The institutional segment has been oversubscribed, thanks to LIC, which came in at the lowest price in the band, of Rs 300. The Government mistakenly based its pricing on the prevailing market price of over Rs 400, unmindful of the fact that it was unrepresentative, due to no floating stock. The issue got oversubscribed 1.2 times.

The dependence on domestic institutions like LIC to bail out troubled PSU IPOs (NTPC, NMDC) means they have fewer resources to invest in the secondary market. Which, in turn, means that it would be a weakish bulwark against FII selling pressure, were it to arise.

The market last week was flatting, with the graph of the BSE-Sensex resembling the ECG of a patient in coma. The next major move would be influenced by global factors, perhaps a financial or political crisis. Till such time, the Indian market would inch boringly and modestly upwards.

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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8 Responses to "Are bubbles all bad?"
PARDHANANI LAKSHMAN
Mar 16, 2010
I sometimes wonder how stupid and illconsidered some of the comments are. The authors really ought to read the articles- and in their case,it would appear to be necessary to do so more than once,before they rush in to post a comment.
You did not say bubbles were good. You merely pointed out some good coming out of the bad resulting from the bubbles. I wonder if these critics have not enjoyed the benefits of Backbay reclamation or of cheap telephony??
Keep writing and keeping us informed. You are providing a valuable service for people like me. We may not always agree with you, but will always appreciate the efforts you put in, to pen your thoughts. Regards
Like 
Govind
Mar 16, 2010
"After all, one's enjoyment of a buffet is not marred by the bigger appetite of one's friend"

A good one. this is the problem with retail investors Forgetting their own appetite and trying to compete with greedy

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r j
Mar 15, 2010
Bubbles ARE all bad in financial and economic environments.
Soap bubbles are ok. They are natural and they are in the bathtubs or in a child's toy that creates them with rainbow colors.
Economic bubbles are created by gambling men and harm the general unparticipating public.
And no it is not easy to set a stock appreciation target and dump the stocks when they attain it because the drum beat to cnbc will drown out and bury your sober goal estimates and keep you from being prudent.

SO ALL BUBBLES ARE BAD BEING CREATIONS OF MANIPULATIVE FORCES.
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prakash
Mar 15, 2010
Dear hip,

Why this Bla Bla Bla....
what people understand from this? Today u talk good. tomorrow morning reverse. I dont find any valid content!!!!have many readers out of 120 cr population.
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Anonymous
Mar 14, 2010
ECG of patient in coma differs much from the person who is not in coma ? Like 
SYJ
Mar 14, 2010
Thanks for the nice witty article. Gives holistic view on the market bubbles and some interesting insight too. One of the best from SFTH. Keep the flow. Like 
LAKSHMAN PARDHANANI
Mar 14, 2010
Dear Sir,
I found your expose on bubbles useful and informative.
I also concurr with your aside on the governance by our politicians as witnessed by the recent scenes in the Rajya Sabha.
However, I take issue with all the middle class scions,the chattering classes, the voluble media and the new Turks that the fault lies with governance alone. Any honest observer of the situation will not find it hard to conclude that the 'governing classes' also include the Sonia Gandhis,the Manmohan Singhs etc., whose dedication to the cause of India's progress cannot be doubted except by hardboiled vested interests.
The disease in India is much deeper. It is the middleclasses who are the real leeches in Indian society preying upon a hapless majority of the poor on whose labours they thrive while at the same time despising them. It is as if the soul that I knew of India of my younger days, has been systematically squeezed out of it. For a country that is on the cusp of many great things this is what people like you, with respect, should also be warning us all about.
On a slightly technical matter, would you say that an invester should invest now or wait for the correction which I have been waiting for, for 2 months? Mark Mobius said about a few months back that he envisaged a correction of upto 30% in emerging economies. Do you agree?
Like 
deepaprakasa
Mar 14, 2010
i like your comment on pitroda committee on bsnl....it is at once satirical and factual....good, racy style...keep it up.... Like 
  
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