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November 18, 1997


Business Commentary/Harshad Mehta

Bear reign will end soon

My prediction is that the weakness in the Indian global markets will run perhaps for another month. The reason: international fund managers who still have a positive return on their books for the year will book their profits and convert their holdings into cash. So the selling will continue for another few weeks before we hit the perfect moment in which to turn the calamity into an opportunity.

The foreign institutional investors will be inclined to sell those counters where they already have an exposure. The stocks in which their exposure is not as heavy will not be totally immune -- few stocks survive in isolation -- but at least the decline may not be as sharp as it could be in some of the heavyweights.

While all this happening, something interesting made me sit up and take notice the other day. Brokers on the Bombay Stock Exchange have been permitted to raise the limit on the outstanding speculative business from a piffling Rs 30 million to Rs 200 million. Within a few days of this the stock market dropped nearly 100 points.

The basic rationale of why this enlargement in the trading volume per broker is important is this: in the earlier regime, a speculative cap of Rs 30 million per broker meant that if the broker had even 50 clients, then the maximum that each client would be able to buy would be the equivalent of 500 Hindustan Lever and 2,500 Reliance shares. Ridiculous!

But times could well be in for a big change. Look at the number of positive developments:

* the Bombay Stock Exchange is expanding its online service, the BOLT, with a vengeance to counter the inroads made into their business by the National Stock Exchange. Each centre that the BSE expands to would be the equivalent of a new exchange. Soon BSE intends to expand to almost 150 centres, raising the potential of an improved aggregate turnover on the exchanges. Not just that, this also means that someone in Jamshedpur can now participate in the badla operations of the BSE with as much ease as someone sitting in Fort, Bombay.

* Coincidentally, the cost of money is real cheap. The markets have failed to ignore even though the carryforward charge (badla) is no more than 10 per cent. The stock markets are therefore sitting on a huge potential which, once turned, could lead to a vigorous rally. Besides, the BSE now requires a margin of 10 per cent only on carryforward transaction which is considerably cheaper than banks requiring a margin of 50 per cent.

* The BSE is giving a trade guarantee to to all: that if the business is carried out on its exchange, it guarantees payment to the end client even if the broker defaults in meeting his obligations. As a result, the risk has equalised; A group and non-A group stocks are in the same boat when it comes to risk in this regard.

* Someone sitting on stocks transferred in his name can now lend on the badla market and earn an interest for the facility of giving supply, without actually selling the stock.

* The badla facility in its present structure is efficient and transparent. With the BSE giving a trade guarantee and a depository arrangement, badla financing is almost now akin to quasibanking, so much so that financiers get a pass book and can convert their scrips into cash with just a single entry.

* The earlier system stipulated that within the overall restriction of Rs 30 million, no broker could enlarge his business beyond Rs 5 million per scrip. That stipulation is now history. It means that brokers can get their clients to trade in sync with market trends instead of saying 'Let me look at whether I am overdrawn in Reliance' before a client wants to buy 1,000 shares.

Given this background where brokers can now trade with bigger positions, do we go back to the H Levers of the world? My answer is that this might not happen. The reason is straightforward: if with a small trading room, speculators could push ITC to a price of Rs 600 and a p/e of around 40-odd, the opening up of more finance for the stock market, is obviously going to make them look at other counters.

Before I come to 'What other counters?', permit me to impress upon the reader how lopsided the stock market has become. Ninety five per cent of the transaction in the A list are centred around a mere 10 counters. What makes them special is that these companies represent the core of this country's wealth creation, industrial assets in the private sector and perhaps even consumer spending.

But there has to be a limit. We can't keep playing the ITCs even as other counters with better earnings quote at a fraction of ITC's p/e. The institutions will have to move to counters in the A list (or even the B1) where the growth is expected to be more than 50 per cent in the bottomline this year, the p/e is less than 7.0 -- and will fall further -- and the yield varies between 6 and 8 per cent.

My reading tells me that with interest rates dropping, the larger institutions, FIIs and hedge funds would prefer to play this segment of the forward list that does not dominate trading. This is an interesting niche in the entire market. The ITCs and the Hindustan Levers of the world are attractive from a trader's point of view because they are liquid, but not attractive from a fundamental point of view because the stocks are ridiculously priced anyway. The potential lies in those companies which are lying at a cheap p/e and which can attract considerably heavyweight buying.

This is not a hollow hypothesis. Take a look at the information technology stocks. At the start of the year, they were quoting cheap. NIIT was around Rs 250, Satyam Computers was around Rs 40 and Tata Infotech was around Rs 400. Once buying interest materialised, the stocks went sharply vertical. NIIT is today in excess of Rs 600, Tata Infotech has more than doubled, while Satyam has surprised most of us -- it has quadrupled. If there is one sector that has taken the stock market by storm it has been the IT area.

It can happen again. The trick, of course, lies in guessing where the hot money is going to hit next. The key lies in understanding the psychology of the principal players on the exchanges -- some of who may not even be sitting in this country. To be right, one has to look away from the principal trend, for that is where the real bargains are hidden.

These are potentially the new plays for the coming months :
* A turnaround in the fortune of cement companies what with the government planning to drive growth in the country's infrastructure.
* Encashing the boom in the sugar industry.
* Companies with a high assets base quoting at low p/e multiples and looking attractive from the point of view of a takeover.
* Promoters with negligible holdings.
* Consumer product companies with a large brand equity.

Some of these companies have a dividend yield which equals the badla outgo. That means the cost of holding these counters is actually nil and once the downside has been secured, the appreciation comes as a bonus!

Once derivatives, options and futures come into play , it would put Indian stocks at par with those of the rest of the world. And the opportunity in these counters could enlarge to become one of the biggest in the world. So when prices fall in the coming weeks, it would be a time to build strategic investment plans, not conclude that money would be better sitting in an FD account.

Harshad Mehta

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