Vijay Kumar Gaba

The benchmark Nifty is down about 15% from its October 2021 closing high of 18477. A broader gauge of the market performance Nifty500 is also down by a similar proportion. However, anecdotally I find that damage to the investors’ sentiments is much worse than what this extent of correction in these indices might be suggesting. There could be multiple reasons for the investors’ despondency. For example—

·         Most of the popular trades of 2020-21 that have attracted a whole lot of new investors/traders to the equity markets have lost materially. The Covid trade (Pharma, healthcare); New listed IT enabled businesses like ecommerce platforms and Fintech; popular disinvestment candidates; PLI beneficiaries; self-reliance and import substitution (Specialty chemicals, electronics) have sharply underperformed the markets. A large number of these stocks have corrected 25-75%.

The non-institutional investors have a tendency to chase popular trades. The beta (correlation with the benchmark index) of their portfolios is therefore much higher than a well-diversified portfolio. Obviously, the losses to their portfolio may be much higher than the extent of fall in the benchmark indices. To make the matter worse, the visibility of recovery of their losses is much lower, as the rationalization of the valuations in the popular trades may be more permanent in nature. We might not see loss making new age businesses; commodity chemicals; generic pharma and API makers; and electrical appliance assembly units etc. trading at crazy multiples in the next few years at least.

·         Most equity and debt mutual funds have yielded negative or nil returns in the past 6 months. The real return on bank fixed deposits has also been negative for the past six months. The global and domestic markets are indicating that the probability of any reversal in this trend is very low for the next few months at least. The New investors, who have not experienced a genuine bear market (e.g., 1990s) may be feeling nervous about losing their hard earned wealth.

·         Nifty Smallcap 100 has lost close to 28% from its January 2022 high; almost twice the losses in benchmark Nifty50 or Nifty500. The actively managed portfolios that have more smallcap stocks (high growth at reasonable valuation) may therefore be suffering more damage than what the benchmark Nifty is indicating.

·         The macro environment (both domestic and global) has deteriorated in recent months, especially after the war broke out between Russia and Ukraine. It appears that the measures adopted to arrest the macroeconomic deterioration may be friendly to the equity valuations. The rate hikes, liquidity withdrawal, fiscal tightening etc. have diminished the visibility of growth capex. There are early signs of consumer demand destruction in discretionary spending due to inflation and higher rates. The investors may be fearing even deeper correction in sectors like cement, metals, consumer electronics etc.

It is important to understand that the markets are caught in a perfect storm – (i) Liquidity is shrinking; (ii) cost of capital is rising which requires target valuations to moderate; and (iii) growth environment is clouded which requires earnings forecast to be downgraded.

The best strategy therefore would be to (a) hold nerves and not panic; (b) review the portfolio for any corrective action that may be needed once the storm passes and the sea becomes calmer. It may not be a good idea to go out on the deck and try catching some fish.