Bull and Bear market – same business, different narratives

Function of underlying sentiments. Analysts, investors, management… everyone plays to the tune and push stock prices into excessive territories

There is a reason why stocks get into under or over valued territories and a significant part of that has to do with the ‘Narratives’.

Narratives about –

  • Sector outlook
  • Management quality
  • Moat/ competitive advantage
  • Potential growth
  • Financial profile

Interesting fact is – the underlying factor essentially remains the same but the narrative is presented and looked upon differently depending upon whether the overall market sentiments are bullish or bearish.

Everyone including management, analysts and investors play their part in creating the hysteria and hence the over bullishness/ bearishness in the stock.

Bull market leads to over promises, casualness and too much optimism. Converse is true during the bear markets.

When the sentiments are positive

  • growth potential seems unlimited;
  • aggressive managements rule the roost and cautious managements are considered boring;
  • moats are considered permanent;
  • every expansion/ acquisition is considered adding to the revenues and profits;
  • any headwind e.g., inflation is considered temporary; and
  • there is least focus on underlying financial structure and margins

When the sentiments are bearish

  • growth potential seems muted/ negative;
  • aggressive managements are looked with suspicion whereas cautious managements are considered gold;
  • moats are seen breaking;
  • expansions/ acquisitions are assumed detrimental to shareholder’s returns or worse as a means to siphon money;
  • headwinds are assumed permanent; and
  • there is extra focus on the underlying financial structure and margins

Above are only some examples, but I think you got the idea.

Yes, there are always selective contrarian voices trying to bring in the needed sanity. However, after being continuously proven wrong due to the underlying momentum in the market, either they themselves convert and add to the frenzy or are remembered only after the tide actually turns.

Few actual recent examples to demonstrate the point –

1. Indiamart

Company was listed in the middle of 2019 with a volatile historical performance. Like any other new age tech company, revenues were increasing but it was loss making and had only turned marginally positive before the IPO.

Post listing, the bottomline started picking up and Covid provided further tailwinds. Analysts/ Investors started listening to the management more closely and expectations started building up.

It’s typical at these times to start looking at India’s macro potential and not the real addressable market. Very less focus was being given on the paying subscriber base, stickiness, growth and revenue potential from those.

Comparisons started getting drawn as to how big Alibaba became and maybe Indiamart is India’s answer to that.

Result – share price increased from about Rs 2,500 in July 2020 to Rs 9,950 in February 2021, i.e., 4x within about 7 mths. At it’s peak, the share was trading at almost 100x P/E multiple.

Then as quarterly performances started rolling in, it became clear that though the Company continues to do fine, maybe it would be wrong to presume extraordinary growth.

Listing of Paytm, Zomato, Policybazaar further weakened the overall public market sentiment around similar companies.

Indiamart’s share price consequently corrected by >50% in last one year and is currently trading at Rs 4,500.

Now it’s getting into the other extreme where people are concerned about the sustainability of the existing growth rates and even retention of the existing customers (as life starts getting back to normal post Covid). Current P/E of 45x is looking steep to many.

The idea here is not to comment on Indiamart’s past performance or future potential but to only highlight the excesses that get created due to the overall sentiments – though the company, business, fundamentals remains same.

2. Metals

March 2020 – metals index at 1600 was same as it was in March 2006 i.e., 14 years back.

Majority had no interest in the sector despite the fact that it had declined by 60% from the highs of January 2018.

Since then the index has increased to 4x within 2 years and is currently trading at 6,484.

March 2020 – World was coming to an end and most of us had no interest in a cyclical sector.

Now – Only metals will perform due to the increasing demand and prices, whereas every other sector will struggle due to inflation.

Now if you are someone (like me) who doesn’t invest in metals (then and now), it doesn’t really matter what was it then or what is it now.

However, that’s not the point of this article. The metal example is only to demonstrate the point about sentiments resulting in excesses.

So… no one wanted to buy it in March 2020 and no one wants to sell it now in March 2022. Sentiments had overtaken then and opposite sentiments have overtaken now.

  • No one could predict excessive demand then and no one is expecting muted demand now.
  • No one had expected extraordinary run up in prices then and no one is expecting moderation now.

As of now the prediction is that metal companies will continue churning decadal high profits, whereas dependent industries like infrastructure, real estate, auto etc will keep taking the product and continue operating at losses and/ or  pass the price increase to the customers.

In my personal view, both situations are unsustainable –

  • Dependent sectors continue taking hit on margins/ operate at losses – so far in general the presumption was that the inflation is transitory and hence short term hit is part and parcel. However, increasingly this presumption is turning out to be false. Result – slow progress, plant shutdowns, delayed deliveries etc. Demand for metals is bound to get hit under the scenario.
  • Pass price increase to the customers – will do no good to the already high inflations levels. Interest rates are bound to harden with consequent impact on the demand/ public spending (and in turn the metals). Besides increasing interest rates will also impact the profits of the highly leveraged metal sector.

(I am intentionally not getting into the impact of the Russia-Ukraine war on the metal prices to keep it simple)

Above two are only examples to illustrate the point on narratives. One can see this happening in many-2 more companies and sectors.

Some more examples, current narratives around them and what is not being questioned –

  1. Hospitals and Diagnostics – Covid lead tailwinds. Will it sustain?
  2. FMCG – inflation hitting margins. What about price increases they are taking and will those prices reverse when inflation subsides?
  3. Hotels – post Covid revival. Assuming normalisation, how are current valuations compared with the pre Covid valuations?
  4. Banks – concerns on the asset quality and growth. Isn’t this counter intuitive to the bullishness on the economy and especially cyclicals?
  5. Auto – supply constraints. What about demand and will it be strong enough to allow companies to tide through this phase of supply bottlenecks?
  6. Electric Vehicles – the future and everyone with big talks is going to be the next Tesla. Are there any constraints both from operational and consumer point of view?

List is endless and we can pick up any company and sector to identify the ongoing narratives and how in most of the cases they are influenced by the sentiments and hence narratives.

How as an investor one gets impacted?

– a momentum investor with strong discipline: these are the best situations.

– others: a contrarian thought process is the only solution. Question everything and keep your guards active more than ever !

Some other interesting articles that you may want to read –

Disclaimer: Above are my personal opinions and no recommendation to buy or sell. Please do your own research and take responsibility for your own investment decisions.

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