Stock market rally makes no sense: Zerodha’s Kamath

The stock market is in a bubble territory with prices being driven by liquidity and not fundamentals, Nikhil Kamath, co-founder, Zerodha & True Beacon, told Fortune India in an interview.

“I’m being candid here. I don’t know what is moving the market. The news is bad; the fundamentals are bad. People are buying because the markets are going up, and the markets are going up because people are buying. There is no underlying reason for the markets to have rallied in the manner that they have,” says Kamath.

Since the lows of March 2020, the benchmark indices have doubled their current levels despite the fact that FY21 was a washout year with the economy contracting by 7.3%. Further, against the backdrop of the poor rate of vaccination and various stages of unlocking in the economy, the World Bank has slashed India's FY22 growth forecast from 10.1% to 8.3%. In fact, the Reserve Bank of India governor Shaktikanta Das, too, had raised concerns over the disconnect between the real economy and asset prices.

Not surprising that Kamath believes the market is glossing over the pain. “Early January-February last year, things were slowing down quite a bit [in the economy], then the pandemic happened. But the recovery [of the markets] is ridiculous. The way it has recovered and rallied has not made sense to many of us.”

While the Sensex and Nifty have cooled off from their July 15th closing highs of 53,159 levels and 15,924, to 52,198 and 15,632 levels as of July 20th, the narrative about a lurking correction is not going away—but calling it the peak remains a challenge. “[There is] no way to really call when the top happens. When the tech crash happened in 2000, people were calling it a bubble from 1996. But it still rallied for four years before it eventually burst,” adds Kamath.

Though on a one-year forward basis, the Sensex is trading at 22x and looks attractive, the fact earnings in FY21 were largely driven by lower taxes, lower interest cost, and lower expenses, the outlook for FY22 looks challenging. Any global shocks and earnings disappointment could impact sentiments on the Street. Against such a backdrop it’s a question of when for Kamath before a selloff sets in. “Are the markets expensive? Yeah, sure. Do I think they will rally over the next many years? Probably not, [but] there has to be a correction at some point,” feels Kamath.

While there are concerns around a bubble in the secondary market, there is euphoria building in the primary market, too, with a record number of issues seen in CY21 thus far and more expected by the end of this year. As per Prime Database, in the first six months of the calendar year, ₹27,417 crore was raised by 22 initial public offerings (IPOs).

Kamath feels that in a majority of IPOs, retail investors will be left holding the can. “I’m not a big fan of IPOs. In the origin of any company, it takes on debt, it has an angel investor, and gets quality money through VCs and PEs and all of that. IPOs are, typically, a time when all of these savvy investors are offloading what they bought historically to the retail public of the country.”

More importantly, Kamath believes such huge issues are detrimental to the secondary market as it sucks out any incremental liquidity. In fact, there are 21 issues which have already been green-lighted to raise a cumulative ₹28,706 crore, while another 26 issues are seeking approval to raise ₹52,476 crore, as per Prime Database.

In other words, the primary boom could trigger a liquidity squeeze in the secondary market, or trigger a selloff by retail investors to invest in the new issues. Kamath believes such a move will be detrimental for the small investor. “If we were to look at the last 20, 30, 40 IPOs and calculate the opportunity cost around buying equity at the same time, equity would have done better. Also, when an IPO is subscribed 40-50 times, while it might sound like a good thing in the news, a certain amount of money has to get blocked for every single person who has subscribed. That liquidity is going away from a market that is already strapped for liquidity because of new margin rules,” feels Kamath.