Investors beware. There is bubble in ‘cats and dogs’

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A major point of discussion in stock markets now is the economy- market disconnect: rising markets in struggling economies. The global economy is in a severe recession; but globally the markets are up by around 40 percent from the March lows. In my letter written in June – “Markets are over-valued, but may rise further”- the possibility of liquidity driving the markets up was analyzed. The US central bank Fed alone has injected around $3 trillion into the global financial system since April. Other central banks like ECB has followed suit. Injection of this humungous unprecedented liquidity through bond buying has raised the prices of bonds and brought bond yields and interest rates down to historical lows. Also, it appears that markets are expecting economic growth and earnings to rebound sharply in 2021. The combined effect of these factors – abundant liquidity, historically low interest rates and expectations of a rebound in growth and earnings in 2021 – has pushed the markets high. Market valuations are high.

New retail investors beware

A major trend in the market presently is the sharp rise in the number of retail investors. Large numbers of new accounts are being opened, many of them by the millenials in Tier 2 and Tier 3 cities. This is a desirable trend and is to be welcomed. However, there is an area of concern. Many of these new retail investors are trading/speculating in the market for short-term gains. Trading is a zero sum game. Long-term systematic investment in good quality stocks/good mutual funds results in wealth generation. This distinction is important. But unaware of this important distinction, many new investors are investing in low-grade stocks – ‘cats and dogs’ in stock market language. Prices of many ‘cats and dogs’ have been pushed up to unjustifiable levels. Stock prices of many bankrupt companies have been hitting upper circuits for several days continuously. This is a highly disturbing, unhealthy and unsustainable trend. For many retail investors this game will end in grief.  

Cats and dogs will be slaughtered in a bear ambush

Bluechips, even if expensive, will survive bear markets. They will bounce back. But ‘cats and dogs’ will be slaughtered in a bear ambush. As explained earlier, this bull run is driven mainly by liquidity. Since the macro environment is highly challenging, a sharp correction can happen any time. Therefore, investors have to be vigilant.

The best insurance in this market is to stay with quality. Quality large-caps will survive bear onslaughts but ‘cats and dogs’ will get slaughtered. This has happened many times in the past. History will repeat. Avoid cats and dogs. Stay invested in quality. Stay safe!

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