11:33 December 19, 2011
As I write today, the Sensex has fallen to multi-year lows closing below 15,500 levels. The highs and lows of the indices is not what I want to discuss, but the divergence between stocks in the same sector. It is a common stock market saying that invest in quality stocks/ blue chips and get returns over time. This may sound too obvious but a quick look at some basic data shows that the premium commanded by quality stocks has widened significantly. What is even more interesting is the gap between companies operating in same sector, whose earnings profile get impacted by same set of external factors. Typically, the premium enjoyed by blue chips is on account of competitive positioning, superior quality management and earnings visibility. Even within the same sector, stock valuations have diverged, and reasons may be amount of leverage and operating cash flows.
We’ve divided the data into two time zones. First is the period beginning from 2004 to the end of 2007 when the bull run was on in full steam. The next period is from 2008 when markets have been in a bear squeeze. Now, investors are chasing quality - quality stocks are becoming pricier whereas the rest is getting beaten out of shape. This is a bear market phenomena. However as the chart shows, in a bull market, at times, even lower quality stocks outperform blue chips.
A cursory look at some market cap data shows how Reliance Capital significantly outperformed HDFC Bank in the bull market. But the moment the market turned, HDFC Bank outperformed Reliance Capital in an even more dramatic pattern. You may recall that in mid-November HDFC Bank had even overtaken SBI in market cap for a brief while. The graphs seem to mirror the movements but of course with an exchange of places. Similar is the story with Larsen & Toubro (L&T) and Jaiprakash Associates (JPA). While JPA outperformed L&T in the bull market, it underperformed or rather fell badly in the bear market. Of course you can always argue that there may be company-specific action in these two pairs which I mentioned.
The famous stock market saying that a rising tide raises all ships holds very true here.
Reliance Capital could have suffered due to a host of issues. We won’t discuss them here. In 2003, HDFC Bank market cap was Rs.6000 crore as compared to Reliance Capital market cap of Rs. 746 crore. By the end of calendar 2007, Reliance Capital overtook HDFC Bank with a market cap Rs. 63,000 crore (HDFC Bank market cap Rs. 51,000). Today, HDFC Bank market cap has crossed over Rs. 100,000 crore while Reliance Capital has crashed all the way to a mere Rs. 6,600 crore.
Let’s move to another sector and look at L&T and JPA. In 2004, L&T had almost 7 times the market cap of JP Associates. In 2007, L&T was only 2.4 times that of JP Associates. Now again, L&T has moved higher with its market cap almost five times that of JP.
The point I am trying to make is that markets tend to behave in extremes and the current divergence will be followed by a mean reversal. When it will happen is a billion dollar question but it will definitely happen. As of now, we are yet to see capitulation when all hands throw in the cards. Last week’s sharp decline shows that people are getting tired and getting out. Till a capitulation happens when blue chips also lose price, we will not see another bull market. I think we are about to enter a capitulation phase now.