Cautious, but no signs of fear

I find the current market narrative on social media being dominated by three topics:

1.    A study released by the market regulator SEBI, highlighting that 93% of traders participating in the Indian derivatives markets end up losing money. In the past three years they have lost over Rs1.8trn, trading future and option securities. Most of these were household (retail) traders, who declared an annual family income of less than Rs five lacs each. A few institutional and high frequency traders made gains at the expense of these retail traders. Intermediaries also gained substantially through brokerage and other charges.

The market participants, observers and policymakers are now debating (i) whether the large players are manipulating the market to dupe retail investors; and (ii) whether the entry of small traders should be restricted in the derivative segment of the securities market.

In the meanwhile, as per the SEBI survey, about 75% of the traders who lost money in trading derivatives in the past two years, have indicated that they would like to continue trading.

I have expressed my views on this on many occasions (see here). I may reiterate, in my view, the regulators should be concerned about systemic risk management and not get into the morality of the trading practices of traders. They should focus on imposing adequate margins and preventing market manipulation. Creating additional entry barriers (higher contract size, income & networth criterion, etc.) will only push the traders towards unauthorized/illegal markets, that will not only cause them bigger losses but also take the manipulators of their regulatory ambit.

2.    The broader markets are sharply underperforming the benchmark indices. It is common to hear investors complaining that while the benchmark indices are scaling new highs every day, my portfolio value is not moving higher, or even declining.

This remorse may be driven by misplaced perceptions and unrealistic expectations. I note that since the Covid bottom of March 2020, the benchmark index Nifty50 has yielded a return of ~200%, while the broader market indices Nifty Smallcap 100 (396%) and Nifty Midcap100 (378%) have yielded almost 2x returns as compared to the benchmark Nifty50. Even in the past three months Nifty Midcap 100 (+9%) has performed in line with Nifty50 (+9.5%). Nifty smallcap 100 has also yielded a positive 5.6% return.

In my view, the sharp outperformance of broader markets shall get corrected to a large extent in the course of next 12 months, as has been the case in all market cycles. This convergence of performance is usually achieved in phases. In the first phase, the benchmark indices rise, whereas the broader markets either rise less or decline slowly. In the second phase, the benchmark indices decline and the broader markets decline sharply. We might be currently in the early stages of phase one.

 

3.    The US and Chinese central bankers have embarked on an aggressive monetary easing program. The market participants are debating the likely impact of this round of monetary easing on markets, especially the commodity prices and consequent inflation.

I am neither an economist, nor a research analyst. Nonetheless, I understand two things – (i) the policy actions take time to reflect in the economic data; and (ii) more often than not the policy measures initiated under duress, may not have the desired impact.

I note that even before this round of monetary easing, the global markets were trading at all time high levels; JPY carry trade was unwinding; the US benchmark yields have risen after the aggressive 50bps Fed rate cut; and crude prices have fallen. I am yet to figure out what this monetary easing will achieve in the short term, except panicking traders that all may not be well with the economy and aiding speculative trade in sub-prime debt and EM equities

Though I am not fearful this morning, I would like to maintain my extremely cautious stance on my investment strategy.