The Message from Speculative Excess

Scan the pages of any daily business newspaper and you will find many dominated by the statutory IPO disclosures of companies tapping capital markets. Other pages dissect pre-IPO grey market premia and post-IPO performance, and publish views on the relative attractiveness of various upcoming IPOs.

Simultaneously, there has been a boom in the number of finfluencers producing detailed analyses of industries and otherwise little-known companies. These analyses usually contain little substance other than fulsome praise for an unknown company’s business, accompanied by attractive AI-generated infographics. Judging by this AI slop that is now plentiful on platforms like X, LinkedIn and Substack, every small- and mid-cap company appears to be a potential multi-bagger in some finfluencer’s eyes, regardless of its business risks or the eye-popping valuations its shares trade at.

Much of this content seems designed to feed a battalion of retail financial-market participants who have apparently found a new cure for their speculative fever. New taxes and regulations that curtailed options trading activity, along with a collapse in option premiums, have forced these erstwhile options speculators to seek alternative destinations for their speculative activity.

Since SEBI appears to have no issues with long-only investing, as its Jane Street order underscores, and with brokerages charging almost nothing for delivery-based trades and plentiful availability of margin funding, striving to become the next Buffett seems to have found favour among these speculators. SEBI appears to have substituted one problem for a worse one that hides in plain sight.

Small IPOs have been booming, margin loans have increased by 500% since 2023, with the bulk going into smaller non-F&O stocks, and finfluencer content has exploded, as has the informal education market, with courses that promise to teach students the secrets of finding multi-baggers. Other courses and content offer up candidate companies, while those offering options-related tips and tricks appear to have faded as the speculative fervour has moved elsewhere.

Speculation or Financialisation
This move towards leveraged investing has propelled small- and mid-cap indices to all-time highs. Little of this has any chance of showing up as an official problem, either to regulators or to participants at large, since it hides under the cloak of investing rather than problematic speculation. After all, isn’t this just further proof of the legitimate financialisation of Indian savings, a clear long-term trend? 

Yet, at its heart, this trend points to a number of problems. First, there is a shift, but not necessarily a reduction, in the nature of risk accompanying this transition. 

Options are risky instruments, but they exist on underlying securities or indices that are themselves liquid. Practically, this implies that an arbitrageur can be incentivised to provide an exit for someone stuck in an options position at some price that yields the arbitrageur super-normal profits. Small caps and many mid-caps have no such mechanism to provide exit liquidity, and many can fall hard and become penny stocks before liquidity appears, making them as risky as the option positions that retail participants once favoured. 

Factor in leverage applied to these positions via margin funding, and it is difficult to see how this new approach to which retail investors seem to be transitioning is any less dangerous than the options positions that SEBI has done much to curb.

Second, and perhaps more importantly, this masks a larger problem. Why is there such a consistently large cadre of financial-market participants waiting and willing to jump onto the next hot financial- market bandwagon? The answer may lie in an over- financialisation of the Indian economy.

A long-standing debate exists among economists over the appropriate degree of financialisation in an economy relative to its real sector. A common measure of this is the market-cap-to-GDP ratio. At about 120%, India’s ratio does not appear excessive compared with numbers north of 200% for several overly financialised economies, but it is well above ratios for industrial powerhouses like Germany and China, where they remain in double digits. 

However, another relevant measure worth considering in judging over-financialisation is the number and composition of people in an economy who are actively involved exclusively in financial markets. 

Given the need that SEBI and the government felt to curb retail options trading via regulations, taxes and action against parts of the enabling ecosystem such as arbitrageurs and finfluencers, there are likely too many financial-market participants relative to underlying real economic activity. Their recent transition to leveraged speculative investment only adds weight to this hypothesis. 

Going by SEBI’s studies on retail trading in options, the average Indian participant in these financial misadventures appears to be largely male, under 30, on a low income, possessing little to no investing experience and hailing from smaller cities and towns.

Clearly, then, a significant section of India’s employable population appears to find a vocation in financial markets rather than setting up or being employed in real-economy businesses. This is possibly also a reflection of poor employment growth and the difficulties of doing business in India, something this author has previously written about.

This clear preference for financial markets over the real economy appears to have translated over time into lower required equity risk premia being used to value most equities. This, rather than claims of superior business models, growth, demographics and governance, likely explains in turn India’s almost persistent overvaluation relative to global equity markets on almost any measure.

Given the hoops that domestic investors have to jump through to be able to invest in overseas equities (20% TCS, anyone?), this overvaluation persists over time as these investors cannot purchase assets priced at more appropriate required equity risk premia. Equity issuers of all kinds, taking advantage of this obviously mispriced and low risk premium and the resulting overvaluation, are queuing up to issue new equity and satisfy buyers, as the business dailies clearly demonstrate.

Retail investors seem to be saying, “I am fine with getting low returns even though they are not commensurate with the risk I am taking because there is no alternative for my sustenance.” This message to the stewards of the economy calls for immediate and consequential reform to improve the ease of doing business, encourage FDI and the formation of real-economy businesses so that employment can become meaningful and productive. Is anyone listening, though?