Bulls, Bears and Other Beasts

by Santosh Nair

  Some promoters paid cash to Ketan to inflate their stock price (some like Zee would later claim that the funds they gave him were for buying other companies’ shares), while some allotted shares of their companies to Ketan and his associates way below the market price. Later, the Joint Parliamentary Committee probing the stock market scam of 2001 would name Adani, HFCL, DSQ Software, Cadila Healthcare, Essel, Kopran and Nirma among the companies that provided funds to Ketan.

  Stocks that took Ketan’s fancy soared to unbelievable levels, making him the new Pied Piper of Dalal Street. On tip-offs, traders blindly lapped up the stocks he was supposedly buying, whether it was true or not, fuelling their rise. If Harshad Mehta was the face of the 1991 bull market, Ketan Parekh was the undisputed poster boy of the bull run that began in January 1999 and lasted about eighteen months.

  But to say that Ketan alone was responsible for the spectacular rise in every stock that he had spotted first would be to overrate his trading prowess. There were limits to how much even the most skilled of operators could influence fund managers and stock prices once trading volumes crossed a certain threshold. In the face of frenzied retail action or herd behaviour among fund managers, operators are quite ineffective.

  Some of the stocks Ketan identified as potential multi-baggers subsequently fetched a huge following among institutional investors, more as a result of the worldwide craze for technology stocks rather than for the business models of the companies. Like Harshad before him, Ketan was not the one who created the wave; he merely rode it skilfully.

  Harshad and Ketan were studies in contrast, though it was widely believed that Ketan was being mentored by the erstwhile Big Bull. By a strange twist of fate, Ketan’s rise to fame coincided with the declining fortunes of Harshad, whose comeback attempt through BPL, Videocon and Sterlite flopped miserably.

  Harshad was brash and flamboyant, and loved to be in the headlines. Ketan managed to keep a low profile for a long time, only too aware of the perils of being in the spotlight. But as the size of his positions kept growing, it became harder for him to stay in the shadows. If Harshad was outspoken and flashy, Ketan was soft-spoken and reclusive. One of Harshad’s major weaknesses, according to those who knew him well, was his inability to sell a stock in good time. He was good at driving up prices to bizarre heights, but his judgement seemed to desert him when it came to encashing them for profits.

  ‘For some reason, selling is anathema to him,’ I have heard many a close associate of Harshad say.

  Ketan had no such qualms. If the trend was bearish, he would not hesitate to sell a stock short. But there was one thing Ketan had in common with Harshad: he too could lose all sense of proportion. As the bull market progressed, Ketan would become increasingly reckless, and eventually pay for his hubris.

  Helping Ketan’s cause was the changed outlook towards stock valuation that rejected conventional parameters. Globally, stock markets were split down the middle. On one side were the new-economy stocks, comprising companies from the technology, media and telecom (TMT), or the information technology, communication and entertainment (ICE) space. On the other side were the old-economy stocks, also known as the brick-and-mortar companies, comprising the rest of the sectors.

  The traditional yardstick of price-to-earnings (PE) multiple for valuing a stock was now considered irrelevant as far as new-economy stocks were concerned. For one, most IT companies were flush with Y2K-related orders from the West, and were logging strong growth quarter after quarter. It was felt that these growth rates could be indefinitely sustained. Another rosy view of the knowledge economy held that unlike their brick-and-mortar counterparts, which had to invest in plant and machinery to increase output, technology firms could easily scale up their operations by simply adding more people. The truth was, nobody knew how to value these companies because there was no precedent.

  By the time the curtain fell on 1998, shares of most of the IT companies had risen three-to-five-fold during the year. Because of my misgivings about the sector, I had missed an opportunity to make some good money. I occasionally punted in a few IT stocks, but lacked the confidence to take big positions because of their steep price rise. I decided to become a convert and embrace the technology faith, but I did not have the conviction necessary for it. I conferred with GB and Monk on the matter.

  Both were not very sure themselves about how long the party in technology stocks would last. But, as usual, GB had his own interesting take on the trend.

  ‘If you ask around, you will find more believers than disbelievers in the technology story. Experience tells me that it is a good sign to have some disbelievers. So long as people are sceptical, the rally can continue. It is only when everybody tells you to buy a particular stock or a sector that you should have second thoughts about it,’ he said.

  Monk had a similar view, though he expressed it differently.

  ‘It is futile to fight a trend, and the trend right now is in favour of technology stocks. As to whether these stocks are worth these prices, only history will tell,’ he said. During the course of the year, I realized that Monk was quite close to Ketan. I made this inference from the stocks Monk was buying through me.

  I need not have worried about being late to the new-economy party. Despite the fairly steep appreciation in stock prices, the action was just starting actually. In March 1999, Infosys raised around $70 million from investors in the US, becoming the first Indian company to be listed on Nasdaq. In October that year, Satyam Computer Services’ subsidiary Sify raised $74 million, listing on the New York Stock Exchange (NYSE). Wipro would join the league six months later. Indian IT companies had finally arrived on the global scene.

  The unprecedented boom in technology shares over the next eighteen months would swell my net worth beyond my wildest imagination. Young traders like me had gained the most – though I must admit I was a sceptic who later converted – as we were not weighed down by baggage from the past. But our seniors were, and when share prices of software companies surged, veteran brokers predicted that the IT boom was no different from other stock market fads of the past and would end up giving grief to those cheering the sector.

  Their scepticism was understandable, considering IT stocks were quoting at PE multiples far in excess of what blue chips like Reliance, ACC, Tata Steel and SBI had seen even at their peak. The veterans refused to acknowledge the new-economy companies to which the conventional approach to stock investing did not apply. In the stock market, too much experience can sometimes be a drawback rather than a virtue.

  I remember one senior broker telling me: ‘Lala, what is this sudden excitement over the computer? After all, it is only a modified version of the typewriter, right? When the typewriter was invented, people had predicted it would change the world. Has it? No. And the same will be true of the computer too.’

  The broker was partly right in that barely a handful of the ‘world beaters-in-the-making’ survived the bust that followed, and many investors lost more than they had made during the bull run. And no, the technology boom did not revolutionize life on earth immediately as expected, though it did lay the foundation for the huge changes in the coming years. The dizzying rise in IT and other new-economy shares would defy logic for about two years. But during that period, there was easy money to be made; it was a period when you were better off not understanding balance sheets, and profit and loss statements. Traders who kept short-selling IT shares, convinced that the fantastic valuations were unsustainable, were nearly driven to ruin. Those who just bought blindly without trying to figure out the reasons for their rise gained the most.

  The bull run hardly presented an uninterrupted, smooth ride to riches; two speedbreakers during the year nearly halted it. But to everybody’s surprise, the market managed to take both events in its stride.

  Year 1999 had started off well for the bulls. Inflation was slowly going down, and with it, interest rates too. The government appeared to have regained its footing as the infighting within the top l
eadership subsided. Technology shares were the flavour of the season, and investors slowly began making a beeline for even the lesser known and sometimes downright dubious companies in the sector. Even news of an old-economy company launching its website was sufficient to get investors excited. Some companies renamed themselves, adding fancy prefixes like ‘technologies’ and other IT terms to attract investors. Of course, most of these companies had nothing to do with technology.

  There was this story about a Calcutta-based software firm that suddenly became a big hit with retail investors. Only later did the buyers realize that Soft Wear was a hosiery firm and not a software firm.

  Sentiment for IT shares was further fired when the Budget offered a tax break to companies making their computer systems Y2K-compliant. It proposed that all expenditure incurred by companies on Y2K-compliance should be allowed as revenue expenditure in the coming financial year. This meant companies could deduct these expenses from their tax liabilities. On the whole, it was a good Budget from the market’s viewpoint, and the bulls showed their approval by lifting the Sensex around 600 points (18 per cent) over the next couple of weeks.

  But clouds of political uncertainty started gathering when the AIADMK withdrew support to the government in the second week of April. The big guns of the market were confident that the BJP would be able to prove its majority in Parliament the following week by making new allies. What followed was an anticlimax. In the narrowest ever loss in a no-confidence motion, the NDA government was defeated by one vote. The Sensex crashed 7 per cent on the news, and many traders suffered huge losses as a result of their overconfidence in the prospects of the NDA. I lost a good chunk of my trading profits, but fared better than many of my peers.

  ‘Never take huge bets on political events,’ Monk had told me a few days ago. ‘Markets may be irrational, but are far more predictable than politicians.’

  The BJP would have won the trust vote but for the Bahujan Samaj Party and National Conference member Saifuddin Soz switching loyalties at the last moment. Surprisingly, the collapse of the government and the prospect of a third general election in four years did not dampen the bullish mood. This, even as tension was building up on the Kashmir border after Pakistani infiltrators seized India’s forward posts in Kargil and refused to back off. A war looked imminent after Indian armed forces mobilized troops in large numbers to reclaim its positions. India began air attacks in the last week of May, and it would be two months before the last of the infiltrators were driven out.

  Logically, a combination of war and political instability should have sent investors fleeing for cover. In fact, the mood in the market was downcast during the first few days of the war at the prospect of a long-drawn conflict. But the market shrugged off these concerns quickly, and by the time India formally declared victory in the last week of July, the Sensex had rallied nearly 30 per cent.

  Technology stocks were on fire. Making money had never been so easy.

  ‘To make money in this market, all you have to do is show up for work and buy a technology stock at random,’ Monk told me one day, when I visited his office for some work. ‘But this also means that the bull market could be nearing its end,’ he added.

  The eye-popping rise in technology stocks – upstarts as well as leaders – had attracted ordinary investors in hordes. Like the professionals, the greenhorns too had it easy, making money by trading stocks. This encouraged them to take even bigger bets without much thought as to the consequences. This was a worrying sign for the seasoned players because traditionally, bull markets have peaked whenever retail investors have stampeded their way through the bourses.

  A stock can be traded only if there is both a buyer and a seller for it. If there are no sellers, buyers will not be able to buy. Trading in scores of stocks would be regularly frozen for want of sellers. Prices would leap 8, 10 or 16 per cent, depending on the intra-day limit set by the stock exchanges for the stocks.

  As the ICE stocks chased each other to new highs, the pedigreed old-economy names floundered in the absence of investor interest. The list of ignored stocks included Reliance Industries, Tata Steel, TELCO, ACC, Grasim, SBI, ITC, Hindustan Lever and Bajaj Auto – once the most sought-after stocks on the bourses and indicators of market sentiment. These companies were spoken of disparagingly by fund managers and brokers, many of them now convinced that these firms had outlived their utility and would be driven out of business before long.

  As for the much-acclaimed new-economy stocks, the majority of them were quoting at unrealistic prices that had long lost all connect with the stock fundamentals. I have never believed in the concept of a fair price for a stock. Price is something that investors are willing to pay at any particular point in time. Almost 99 per cent of the time, stocks are quoted below or above their true worth. My theory is that there is a price at which you can hope to make a decent return, and that price need not be a fair one. But right now, it was the ‘greater fool’ game in full swing. People bought stocks at ridiculous prices, confident that somebody else would buy them at even more preposterous prices.

  Value investors like Radhakishan Damani, Rakesh Jhunjhunwala and many old-timers considered technology stocks overvalued, and short-sold them. But the stocks rallied even more, forcing them to square up their positions at a loss. The bears would wait for a while, and again short-sell at a higher price, hoping to recoup their losses. The effect would be the same; they were simply making more losses as the stocks continued to climb. It was an open secret that many stocks owed their lofty valuations to promoters funding brokers and operators to rig their price. Bears had reason to believe that they would eventually triumph. After all, the market could not ignore fundamentals forever, they argued.

  In the past, many promoters had tried to inflate their stock prices. More often than not, these attempts had culminated in a wrecked stock price and regulatory action. In 1992, the bears had made a killing when the securities scam finally surfaced, when only a couple of days before it seemed certain that many of them would be driven to bankruptcy. In 1998, the bears had again dealt Big Bull Harshad a crushing defeat in the BPL, Sterlite and Videocon stocks.

  They thought the same approach would work with technology stocks too. There was nothing wrong in the basic principle of going after overvalued stocks. Except that this time the frenzy was too widespread for any chance of success for the bears.

  One evening, I happened to be in Rakesh Jhunjhunwala’s office along with a few of his associates. He was not in the best of moods as most of his bearish calls on technology stocks had gone wrong. The topic of discussion was, naturally, the tech boom.

  ‘I tell you, this tech boom simply cannot sustain,’ Rakesh said, looking at the prices on the screen. ‘As share prices start climbing, IT companies will issue stock to raise money. The more their floating stock, the slower prices will rise. That is because there will more people selling every time the price rises. IT shares have been rallying so far partly because of a self-fulfilling prophecy. People buy, share prices rise, and more people buy, thinking the price will climb further. But once share prices stall, people will stop buying. Then the vicious cycle will begin. People will start selling, prices will fall, and there will be more selling. The stocks will then simply collapse as everybody rushes for the exit door together,’ he said.

  ‘This logic is indisputable, Rakesh. The stock prices will collapse at some point. But the question is, when?’ asked KD, one of his close friends. That was true. Nobody could predict how long the stock prices would climb before running out of steam. Few could have said that to Rakesh’s face and got away with it. I was half expecting Rakesh to get into an argument with KD to prove his point. But Rakesh said nothing. KD was among the few whose views he respected.

  Promoters dabbling in their stocks was nothing new. Usually they were discreet about it. This time around, stock-rigging by operators with help from promoters seemed to have become institutionalized. Promoters appeared unfazed by market talk linking them to o
perators.

  There were some other unhealthy developments too. I learnt from my friends that quite a few politicians were becoming active in the market, picking up stakes in shady companies through ‘fronts’. Earlier, politicians were content with a fixed pay-off from promoters in return for policy favours. But having realized that there was more money to be made as ‘equity partners’, many of them had decided to tweak their ‘business models’.

  Forever in search of the best performing markets, FIIs had stepped up their investments in Indian equities in 1999. Many of them chose to route money through investment companies registered in Mauritius. The Double Taxation Avoidance Agreement (DTAA) India had signed with the island nation in the early 1980s allowed for Mauritius-based entities to pay capital gains tax at Mauritius rates and not India rates. As Mauritius did not tax capital gains, the FIIs did not have to pay any taxes on their capital gains in Indian stocks.

  Given that the rules allowed for it, there was nothing wrong in what they were doing. But the overwhelming majority of the so-called investment companies claiming to be based in Mauritius were nothing more than ‘post box’ companies. They merely had a postal address. Their funny business did not end there. For a juicy fee, many FIIs were willing to open what was called a ‘sub-account’ for Indian promoters and market operators.