How to identify stock market bubble
There are many signs that keep on repeating in every stock market bubble which can offer early warning signals to investors with high stakes. Let's look at a few here
String of successful IPOs
Lot's of IPO offers. Read lot of groups realizing that they can get premium valuation in the current market and hence lining up for listing on the exchanges. High premium earned easily means bubble. This becomes very evident as even low quality company IPO's gets oversubscribed at premium valuations and the lineup of IPO's starts increasing at an accelerated pace. This signifies that there is a hurry to raise money from the market before the opportunity goes away, since the next such opportunity will come back again only after a really long time.
small/midcaps preference over large caps
preference of small and midcap stocks over large caps signals shift of focus from safe & steady to quick & risky among investors. Just like IPO's this is fine upto some extent as long as high quality midcaps with good potential are running up, but when low quality mid & smallcaps and unheard names (penny & paper companies) start hitting upper circuits everyday you are definitely in a bubble phase
High Volatility
Significant run up on mildest of good news and complete crash on a hint of bad news points to the same money being rotated to capture as many opportunities as possible. This is also called hot money. High volatility indicates a higher percentage of hot money floating in the market instead of stable long term investments. Hot money is usually used for trading and is leveraged multifolds to amplify the effect. This kind of money will exit the market on the first sign of trouble at any available market price, leaving the stable investors high & dry specifically if invested at higher levels pumped by hot money.
Retail participation:
Retail is just a nice word for unwise or inexperienced people in stock markets. They do not take their own investment decisions but rely on tips and advise from others. Also they are hard to convince and slow to act because they have little knowledge about the working of the stock market and hence remain skeptical for most of the time. So when they finally decide to act, they are almost certainly the last one's to act which also means when the retail starts to act it signifies the beginning of the end of the current cycle. If they start to buy in big numbers, it marks the beginning of the end of the bull cycle and if they start to sell in big numbers, it marks the beginning of the end of the bear cycle. This is also because retail trades only on greed on the buy side and fear on the sell side. Interestingly high volatility attracts more retail participation because they like spectacular and fast moves. 20% in one day attracts retail attention but 2% for 10 trading sessions is boring for retail. This is also one of the reason why retail investors enter the stock market in the last phase of the bull run i.e when it gets more volatile, makes more news and attracts more attention.
Ignoring bad news & deteriorating macros
Bad monsoon, lower job and wage growth, high interest rates, geopolitical tensions, terror attacks, business frauds, corporate governance issues and corruption, unstable political environment, growing NPA's in banking system, lot of corporate defaults, institutions/states/countries going bankrupt ... no problem stock market always goes up. When you feel that way, you know it's a bubble. In other words it is also called euphoria. Market always sees good even in bad news. Fed decided not to raise rates because of poor job growth is regarded as great news because that means cheaper credit to invest in risky assets but is actually bad news that the economic recovery is not happening inspite of all the efforts put in but market takes it as a good news.
Hectic market activity
Lot of analysts and stock gurus showing up everyday with new multibagger ideas daily, lot of investment blogs :) , lot of M&A and fund raising activities at insane valuations, lot of new startups, lot of media coverage, lot of demat & brokerage accounts getting opened, lot of talk of HNI's and investment agents, people claiming to have bought cars and house out of money earned from stock market and suggesting the same to others, lot of leveraging, loan taking and financial transactions. Basically very high money velocity in the market. Lower almost recessionary value for hard physical assets like gold, silver and real estate.
Insider selling
Lot of promoters selling or diluting their stake in the company they are running and raising money either through institutions or through open market. You might also see huge exits from large institutions or long term funds. However the entire selling gets absorbed by the market because of the retail euphoria who are ready to pick up stocks at any price.
Technicals
there are several ways to identify cycles using advanced technicals like elliot waves however for the layman the easiest way to identify bubble is to look at one year graph of many stocks and indices and check for exponential or spike patterns towards the later end in most of the graphs. This simple pattern is on the way up but if the trend has already reversed look for lower lows or look for sharp high volume falls followed by sluggish low volume recoveries. You can also look at technical ratios like stock and sector P/E. In the Indian context 15 and below is investment worthy and 30 and above is bubble formation.
Warnings from stock market veterans
Highly experienced and successful stock market veterans detect bubbles much earlier than retail & media and give out very soft warnings for two reasons, one they are in the process of positioning themselves for the coming bust and don't want to spread panic, second they know that they detect the bubble earlier so there is still some time for the market to run up during which things could change so no point in making hard predictions. So they give out very subtle warnings.
Remember everytime things are slightly different so stock market analysis should be done correlating or using a combination of multiple factors and keeping in mind the broader macros and current context along with future projections.
There are many signs that keep on repeating in every stock market bubble which can offer early warning signals to investors with high stakes. Let's look at a few here
String of successful IPOs
Lot's of IPO offers. Read lot of groups realizing that they can get premium valuation in the current market and hence lining up for listing on the exchanges. High premium earned easily means bubble. This becomes very evident as even low quality company IPO's gets oversubscribed at premium valuations and the lineup of IPO's starts increasing at an accelerated pace. This signifies that there is a hurry to raise money from the market before the opportunity goes away, since the next such opportunity will come back again only after a really long time.
small/midcaps preference over large caps
preference of small and midcap stocks over large caps signals shift of focus from safe & steady to quick & risky among investors. Just like IPO's this is fine upto some extent as long as high quality midcaps with good potential are running up, but when low quality mid & smallcaps and unheard names (penny & paper companies) start hitting upper circuits everyday you are definitely in a bubble phase
High Volatility
Significant run up on mildest of good news and complete crash on a hint of bad news points to the same money being rotated to capture as many opportunities as possible. This is also called hot money. High volatility indicates a higher percentage of hot money floating in the market instead of stable long term investments. Hot money is usually used for trading and is leveraged multifolds to amplify the effect. This kind of money will exit the market on the first sign of trouble at any available market price, leaving the stable investors high & dry specifically if invested at higher levels pumped by hot money.
Retail participation:
Retail is just a nice word for unwise or inexperienced people in stock markets. They do not take their own investment decisions but rely on tips and advise from others. Also they are hard to convince and slow to act because they have little knowledge about the working of the stock market and hence remain skeptical for most of the time. So when they finally decide to act, they are almost certainly the last one's to act which also means when the retail starts to act it signifies the beginning of the end of the current cycle. If they start to buy in big numbers, it marks the beginning of the end of the bull cycle and if they start to sell in big numbers, it marks the beginning of the end of the bear cycle. This is also because retail trades only on greed on the buy side and fear on the sell side. Interestingly high volatility attracts more retail participation because they like spectacular and fast moves. 20% in one day attracts retail attention but 2% for 10 trading sessions is boring for retail. This is also one of the reason why retail investors enter the stock market in the last phase of the bull run i.e when it gets more volatile, makes more news and attracts more attention.
Ignoring bad news & deteriorating macros
Bad monsoon, lower job and wage growth, high interest rates, geopolitical tensions, terror attacks, business frauds, corporate governance issues and corruption, unstable political environment, growing NPA's in banking system, lot of corporate defaults, institutions/states/countries going bankrupt ... no problem stock market always goes up. When you feel that way, you know it's a bubble. In other words it is also called euphoria. Market always sees good even in bad news. Fed decided not to raise rates because of poor job growth is regarded as great news because that means cheaper credit to invest in risky assets but is actually bad news that the economic recovery is not happening inspite of all the efforts put in but market takes it as a good news.
Hectic market activity
Lot of analysts and stock gurus showing up everyday with new multibagger ideas daily, lot of investment blogs :) , lot of M&A and fund raising activities at insane valuations, lot of new startups, lot of media coverage, lot of demat & brokerage accounts getting opened, lot of talk of HNI's and investment agents, people claiming to have bought cars and house out of money earned from stock market and suggesting the same to others, lot of leveraging, loan taking and financial transactions. Basically very high money velocity in the market. Lower almost recessionary value for hard physical assets like gold, silver and real estate.
Insider selling
Lot of promoters selling or diluting their stake in the company they are running and raising money either through institutions or through open market. You might also see huge exits from large institutions or long term funds. However the entire selling gets absorbed by the market because of the retail euphoria who are ready to pick up stocks at any price.
Technicals
there are several ways to identify cycles using advanced technicals like elliot waves however for the layman the easiest way to identify bubble is to look at one year graph of many stocks and indices and check for exponential or spike patterns towards the later end in most of the graphs. This simple pattern is on the way up but if the trend has already reversed look for lower lows or look for sharp high volume falls followed by sluggish low volume recoveries. You can also look at technical ratios like stock and sector P/E. In the Indian context 15 and below is investment worthy and 30 and above is bubble formation.
Warnings from stock market veterans
Highly experienced and successful stock market veterans detect bubbles much earlier than retail & media and give out very soft warnings for two reasons, one they are in the process of positioning themselves for the coming bust and don't want to spread panic, second they know that they detect the bubble earlier so there is still some time for the market to run up during which things could change so no point in making hard predictions. So they give out very subtle warnings.
Remember everytime things are slightly different so stock market analysis should be done correlating or using a combination of multiple factors and keeping in mind the broader macros and current context along with future projections.
No comments:
Post a Comment