When the bulls are on a rampage, everything looks optimistic. In this phase of the market, there will be lot of sector rotation and thus the stock rotation. Sector rotation is the euphoria around a particular sector because of a big fundamental move or structural change for instance, a govt policy to boost infrastructure, a major change in the macro factors of an economy, etc. The initial reaction to such a move is an immediate spike in the stock prices of the sector under consideration.
Stock picking: Roller - coaster ride for bourses
Once, the stock ideas are dried up in that particular sector then an allied sector is picked up and reasons are doled out suggesting why this sector would do well and benefited directly or indirectly due to the earlier fundamental change. For instance, when the govt announces investment in say, infrastructure related activities, the stocks under this sector like that of the existing pure infrastructure plays, construction, engineering and road/rail stocks are shot up.
Once, these stocks are assessed, evaluated and priced-in, there would be another churn of an associated sector with this announcement that would benefit due to the earlier stocks/sector. Now, that the pure play is done, the allied sectors of steel, cement, etc. come on-board to participate in the party.
Again, as the process repeats to earlier motion, the stocks in these sectors go up. Within this theme, the stocks with not-so- good fundamentals also ride along with those of the better ones. This is what jubilant inflows does to the market and our senses.
As the valuations sprout high, to justify these prices, the growth figures are churned up. Then the other fundamental factors which were existent much before the earlier announcement like the rich demographic dividend, the improved mobility and increased affordability are brought into the limelight to substantiate the earlier claims.
This brings in further set of new stocks/sectors that could get the allocation for the fresh inflows. For instance, as the possibility of road infrastructure improving, could lead to sale of more cars and thus more fuel consumption. This brings in the banking, finance companies and even the oil marketing companies into attention as they would fund this expansion. These estimates now seem real when looked through the existent fundamental prism and thus the valuations seem to get a boost.
At this point, you would begin to hear how people have ‘identified’ a great stock and made money and words like break-out, multi-year highs, etc. would become commonplace. You would suddenly feel left out and certainly want to ride the bandwagon. Folks mention about long-term, growth story, comparisons to another country/times, etc, to supplement the trend and bringing in more inflows in to the market.
This cycle doesn’t end till reality dawns and hits hard in the face. It’s when the quarterly results are announced and seem to not meet with the expectations of the street, the initial stocks/sector either loses sheen or worst downgraded. Now, that the expectations are hit, the allied sectors and their associated ones face the similar music. This could lead to corrections in the prices and the worst losers are those with bad financials or fundamentals that have earlier run up with the wave/crowd.
The moral I’m trying to draw up here is that, it’s always important to bet on those stocks which have good financials and fundamentals like good management, capabilities to gobble up opportunities and also resist/fight any upheavals.
These are the hallmarks of a great company and one could invest (not just trade) in these stocks to gain rich rewards. When investing in these companies, the price is only just an arbitrage and wouldn’t define the reason for your purchase or entry. As Horace put it, “Many shall be restored that are now fallen and many shall fall that are now in honour” and if your research is lopsided, the travails would only grow stark and it would be difficult to redeem any value.
The author is co-founder of Wealocity, a wealth management firm and could be reached at firstname.lastname@example.org