Do it yourself

In the past seven trading sessions, the benchmark Nifty 50 has managed to fully recoup the YTD2025 losses, soothing the ruffled feathers to a large extent. The broader markets have also regained some of the lost ground, though the midcap (-10% YTD2025) and small cap (-15% YTD2025) indices are still in the negative territory.

For the financial year 2024-2025, Nifty (+6.5%) has yielded a decent return, which is marginally lower than China (+12%), the US (+10%) and Europe (+9%), but much better than the other Asian peers like Indonesia (-11%), Japan (-6%) and South Korea (-5%). Broader markets in India are also positive FY25 (Midcap +8% and Smallcap +5%).

Now the question is “how does the market look from here?”. I shall deal with this question in some detail next week. However, to close this financial year, I must say this.

In my view, the collective wisdom of the market in India has appeared to have assimilated all the known events and anticipated developments regarding the economy and earnings, that could have sustainable impact on the stock prices. The market pendulum has tested both the extremes in the past seven months. A major surprise, positive or negative, or a black swan event, may only cause the market to breach these extremes in the next 6-8 months.

The most probable scenario for the next month is that the market swings get incrementally shorter in the next 9 months, as additional evidence of earnings recovery and improvement in the macroeconomic conditions emerges. We may also have more clarity on the global economic and geopolitical conditions in this period. In my assessment, for most of the time in the next 9 months, Nifty may oscillate between 22500-24500 (with occasional excursions outside this range) and find a sustainable pivot around 23500-24000 level.

A new market cycle might begin, once the market stabilizes around the equilibrium level and more credible assessments are available about the future earnings trajectory and macroeconomic growth and stability.

Recent interaction with the market participants indicates that the sentiment of fear is now strongly dominating greed. Most of the investors/traders are complaining of pain in their respective portfolios.

Indubitably, the portfolio values have corrected noticeably from their September 2024 high levels. However, the damage is far less as compared to the previous major bear market, which lasted for almost thirteen months (2008-2009), followed by a 20-month period of recovery (March 2009-November 2010) and a three-year period of consolidation (November 2010-October 2013).

We had a tentative two-year market cycle between 4Q2013 and 1Q2016, before the latest proper bull market started at the end of February 2016. Notably, this bull market has been the longest one (8 years); and it is still not certain that it has ended on 26^th September 2024.

Pain-check

In my view, the pain from stock price corrections could be of two types – absolute and emotional.

Absolute pain occurs when an investor or trader loses his capital permanently. This may be due to excessive leverage, error of judgement in the stock selection, and/or liquidating portfolio at a low point due to panic.

Emotional pain occurs when an investor or trader becomes greedy and internalizes the excessive returns as normal. The pain is felt when the market reverts to mean and excessive returns made during the euphoric phase evaporate, leaving only normal returns for them.

It is therefore important to use a correct reference point for “pain-check”.

So far, most of the regular investors/traders may be feeling emotional pain only, as the correction so far has been mild and they are still earning normal returns (13% CAGR on Sensex and 18% CAGR on BSE Smallcap) since February 2016 when the latest bull market started.

For traders and investors who started investing/trading in stocks and/or mutual funds in 2020, the returns are still above normal (15% CAGR on Sensex and 26% CAGR on BSE Small Cap since September 2020 when lockdown was lifted after the first Covid wave).

It is important to note that during the last bear market (2008-13), stock price correction lasted for 13 months - from the end January 2008 to early March 2009. However, January 2008 high levels were not breached till October 2013. The 2008-09 correction was so severe that it not only eroded entire gains earned during July 2006 – January 2008, but erased a significant part of the invested capital. In the end (March 2009), the Sensex was 18% lower than the starting (July 2006) level; while Smallcap (-41%) and Midcap (-36%) were sharply lower. In comparison, the investors and traders are in a significantly comfortable position in the present correction.

The sentiments of greed (risk-taking) and fear (risk-aversion) are two key factors that determine the breadth and depth of the stock market performance over a short term.

In the risk-averse phase usually themes like large cap, defensive, value, dividend yield, etc. lead the market performance. In this scenario, the market breadth is usually narrow; fewer companies raise fresh capital; volatility is low; and market breadth is consistently poor.

On the other hand, in the risk-taking phase, themes like small and midcap, growth, cyclicals, etc. lead the market performance. In an environment supporting risk-taking, usually the market breadth is strong, volumes are above average, and volatility is higher. The primary market is very active in this phase, as a larger number of entrepreneurs look to raise fresh capital for growth and deleveraging.

The year 2024, however, has seen some divergent trends. Several contradictions prevailed, which not only raise doubts about the validity of the current risk-taking phase in the conventional sense, but also present a higher probability of emergence of a severe risk-aversion phase in the near term. For example, consider the following:

·        Small and midcap stocks consistently outperformed the benchmark Nifty throughout the year, despite several risk affecting events like BJP not securing majority in the general elections in India; serious escalation in the Middle East Asia geopolitics; outcome of presidential elections in the US threatening a full-scale tariff war; growth slowing materially in Europe, China and India; sticky inflation restricting global easing cycle; corporate earnings failing to meet expectations etc.

·         The promoters raised over Rs three trillion through initial public offerings (IPO), qualified institutional placements (QIP), and rights issues. However, most of the QIP and rights issue money was used to deleverage the balance sheets rather than expanding capacities – usually a sign of risk-aversion. Even many of the IPOs were 'offer for sale', where the promoters diluted their stakes.

·         Foreign portfolio investors have been net sellers in Indian equities in the year 2024. In the secondary market, FPIs sold over INR 1.1 trillion worth of equities in 2024. However, they bought almost a similar amount in the primary market. The share of the Indian listed market capitalization owned by FPIs fell to ~16%, the lowest level in a decade. The domestic institutional investors however purchased over INR 5.1 trillion worth of equities in the secondary market. The share of the market capitalization owned by the household investors increased to the highest level in the past 15 years.

Historically, the correlation of FPIs’ net flows and Nifty returns in a given year has been poor; but the rise of household share in stock ownership has mostly led to a risk-aversion phase in the markets.

·         Despite significant outperformance of the small and midcap stocks, the market breadth and overall traded quantity has not been supportive of a risk-taking trend. In the 6 out of first 11 months of 2024, market breadth has been negative. Overall, the market breadth is neutral. The traded quantity has been mostly below average in the last six months.

·        The implied volatility has been mostly moderate to low, except for a brief spike in May 2024 (election month), usually not a sign of a risk-taking phase.

 

The life of equity investors appears to be becoming more tense with each passing day, regardless of the indices scaling new highs. This applies more to the professional investors (fund managers etc.) as compared to the individual investors. I gather from my conversations with the professional investors that they are finding it increasingly difficult to sustain their performance of the past three years.

The assets under their management (AUM) have increased multifold in these three years, but the stock of quality investable equity shares has not grown at a matching pace. Some of them have been reluctantly deploying the incremental flows in the limited number of available stocks, resulting in unsustainable rise in prices; whereas the others have chosen to go down the quality ladder and invested in the poor quality or apparently absurdly valued stocks.

Obviously, they lack conviction in their portfolios, but continue to hold it and even grow it due to professional compulsions. Arguably, they are riding the proverbial tiger with no end in sight for the ride. No surprises that they are stressed and desperate at the same time.

Individual investors on the other hand appear bothered by concerns, which have mostly emanated from psychological factors, perceptions and overflow of news flow and analysis. For example-

·         The popular stocks which led the market rally in 2021-2023 (specialty chemicals, railway, defense, PSU banks etc.) have been underperforming in recent months. The investors who have material positions in these stocks are suffering from “other queue always moves faster” syndrome. Their anxiety is further elevated by the fact that the sectors like IT Services which were most undrowned in 2023 have recently done exceedingly well.

·         Most investors have apparently internalized the exceptional returns they have earned in the post Covid period into their normal portfolio return projections. The analysts are now forecasting the market returns to revert to mean over the next couple of years, as the operating leverages fade and corporate debt begins to rise again, economic growth plateaus, and earnings growth trajectory descends to mid to low teens. Many investors are not finding the idea of 10-12% return on their equity portfolios exciting enough.

·         The news flow and analysis are becoming increasingly confusing for them. In the evening, they hear that the imminent rate cut by the US Fed is likely to drive the global markets higher. However, in the morning they are presented with analysis of how the past episodes of Fed rate cuts have triggered sharp corrections in equity markets.

A host of analysts advise them to invest in gold; then some expert comes and tells them silver will do much better in the coming years as the demand for EV batteries and semiconductors rise. Credit analysts claim that bond returns shall outperform equities in a falling growth & rate scenario. There is no dearth of analysis on how cryptocurrencies are going to annihilate gold.

·         There is persistent fear mongering of WWIII led by Russia and China. Astrologers are predicting retrograde Saturn, Jupiter and Mercury in the winter of 2024 could cause a massive crash in markets.

While all this is agitating the investors’ mind, an IPO lists at 135% premium to its issue price, luring them to allocate even more money to equities!!

The first half of the year 2024 has been good for global markets. Despite disappointment on rate cuts, geopolitical concerns, sticky inflation, and political changes in many countries, stocks, precious metals, industrial commodities and crypto made a steady move up with very relatively low volatility.

A notable feature of the global market movement in 1H2024 was the stark underperformance of Asia ex Japan, even though the Japanese equities being the best equity markets amongst the major global markets. Brazil also underperformed despite a decent rally in commodities.

Another notable feature of global markets was the narrow market breadth of US markets. Though the benchmark indices scaled new highs, it was mostly due to parabolic rise in a handful of technology stocks.

At present equity markets appear strong on the back of a resilient demand environment, well anchored inflationary expectations and peak interest rates. Fears of earnings failing to match the stock price rise, escalation in geopolitical tensions, spike in energy prices, uncertainties about the policy direction post the US presidential elections, and erratic weather conditions are some points of concern.

India performance – 1H2024

Indian markets performed very well in the first half of the year 2024. Though Indian equities underperformed the developed markets in line with the global trend, it did very well within the emerging market universe. The key highlights of the India market performance could be listed as follows:

·         The benchmark Nifty50 gained ~10.5% during 1H2024; while the Midcap (+20.7%) and Small Cap (+21%) did much better. Consequently, overall market breadth has been strong.

·         Two third of the market gains came in the month of June 2024, post the elections. This was contrary to the pre-election consensus that BJP failing to secure a majority on its own may result in sharp decline in market.

·         The total market capitalization of NSE is higher by ~21%; more than gains in the benchmark indices – implying that stronger gains have occurred in the section of the market beyond indices.

·         The number sector outperforming the benchmark indices far outnumbers the sector underperforming. The rally was led by Realty, PSUs (mostly power, defense, and railway), Auto, infra and energy. The Capital Goods and Heavy Engineering sector have been the flavor for the period. Particularly, the businesses catering to sectors like defense, railways, and road construction did extremely well. Banks, IT Services and FMCG were notable underperformers.

·         Ship builders were the notable outperformers amongst the individual stocks. No conspicuous sectoral trend was seen for the losers.

·         Institutional flows to the secondary equity markets were positive for five out of the six months. 1H2024 witnessed a total flow of ~INR3559bn, despite FPIs outflows of Rs320bn. The correlation of institutional flows with Nifty returns remained poor (~48%).

·         The rates, currency and yields were stable in 1H2024. Policy rates were unchanged; while money market rates were marginally higher by 15bps. Deposit rates did not see much change while lending rates were higher by 10-15bps.

·         The overall Indian yield curve shifted lower and flattened completely, as the RBI maintained the status quo on policy stance.

·         The economic growth surprised on the higher side with the Indian economy recording a growth of 8.2% for FY24, beating all forecasts materially. Fiscal balance also improved with FY24RE fiscal deficit coming at 5.8% and FY25BE of fiscal deficit at 5.1%.

·         CPI inflation has inched closer to the lower bound of the RBI’s tolerance band of 4%-6% with May’24 CPI inflation number coming at 4.75%.

• Corporate performance has shown resilience in recent quarters, with sales growth recovering, margins improving and RoE rising. Banks reported consistent improvement in the asset quality and profitability.

Yesterday’s post (No margin for error) evoked a multitude of thoughts. Some readers have challenged the premise that the broader markets, especially the small-cap stocks, have sharply outperformed the large-cap components of the benchmark indices. They have argued that —

·         Nifty Next 50 Index (YTD higher by ~21%), which comprises the top 50 stocks outside the Nifty50 (YTD higher by ~2.7%) universe, has performed much better than the Nifty Midcap100 (YTD higher by ~9%) and Nifty Smallcap 100 (YTD higher by ~10%) indices.

·         If we exclude private banks and IT services stocks from the Nifty50 universe, the rest of it has performed better than the broader market indices.

·         These statistics (index performance) completely fail to present a correct picture of the market. The narrative that small caps have done better than large caps is mostly false. On a risk-adjusted basis, large-cap stocks may have done far better than their smaller peers.

·        Even in developed markets like the US, a few large-cap stocks have done extremely well and broader markets have underperformed sharply. The discount of small-cap valuation vs the large-cap valuation in the US markets is the highest since the dotcom burst in 2001.

In my view, all these are fair points. However, my premise behind “no margin for error” was entirely different. I wanted to communicate that –

(a)   Presently, the small investors appear edgy to me. They have invested assuming a clear blue-sky scenario. Any sign of the dark clouds on the horizon would make them jittery and they might look to exit their positions.

Empirical evidence indicates that these small investors prefer to invest in smaller businesses where the chances of making big returns are significant. Besides, these investors have very low risk appetite. If the market witnesses a sharp fall, due to whatever reason, they may seek to exit their position. However, given that the liquidity dries very fast in the broader market their exits could come at a significant impact cost. On a bad day, the exit cost could be 20-50% more than what they would have assumed in a normal market scenario.

(b)   A large section of these small market participants is indulging in option trading. The potential losses in the options segment could be substantially higher and permanent since the single stock options tend to become extremely illiquid in case of sharp moves in the underlying securities.

(c)   The standard investing arguments – invest for the long-term; ignore intermittent volatility; small-cap yield a much larger return than large cap over a longer term, etc. – are very much true. However, it cannot be denied that human psychology and the personal circumstances of individual investors override these arguments. The forces of fear and greed dominate the day to day investment and trading decisions of individual investors. If the basic assumptions behind an investment decision fail or the overall market sentiments turn negative, the fear overwhelms the investing decisions of investors with a low-risk appetite. This is where most of the losses occur.

My favorite fund manager highlighted “NVIDIA is more volatile these days than even SME segment. More people would have lost money trading in NVIDIA than the number of investors who would have made money holding it. Trading is for mental wellness, while investing is for material gains”.

I cannot disagree with this proposition. I think most people would agree with it, in principle. But then how many of us live the way our parents and teachers guided us to do!!!

Equity markets are making new highs every day. Other assets like gold, bitcoin, bonds, cash, real estate, etc., are also performing decently. Logically, investors should be happy and looking forward to a great holiday season. However, multiple interactions with investors and other market participants, over the past couple of weeks, indicate to the contrary. Investors appear stressed for a variety of reasons.

Have you ever been to the vegetable market after 9:30 p.m.? The market at 9:30 p.m. is very different from the market at 5:30 p.m.

The benchmark Sensex has recorded its new all-time level today, surpassing its previous high level of 63583 recorded in early December 2022. Nifty50 is also few points from its previous highs. In the past six months, since December 2022, both the indices have taken a huge swing of over 10%.

Optically the markets may appear flat for the past six months, as the benchmark indices are almost unchanged; but a deeper dive would indicate that many material shifts have occurred in the market during this period of six months. For example-

·         Nifty50 is almost unchanged for the past six months, Nifty Midcap100 has gained over 9% and Nifty Smallcap100 has gained over 7% in this period.

·         The sectors that led the markets to new highs in the post Covid period, i.e., IT Services, Pharma, Energy and Metals have actually yielded negative returns in the past six months; while the FMCG sector has been the best performer in this period.

·         Nifty PSU Banks that are the best performing sector for the past one year, have actually yielded a negative return for the past six months.

·         Despite the turning of rate cycle upwards, popular rate sensitive sectors like Auto and Realty have been amongst the top three performing sectors.

Despite sharp outperformance of broader markets, average market breadth for the past six months has been mostly negative. The months of January-March 2023 in fact witnessed the worst market breadth in over two years.

Another pertinent point to note in this context is that Indian markets have sharply underperformed the most emerging market peers and developed markets in the past six months. Note that in 2022 India was one of the top performing global markets. This is in spite of net foreign flows being positive in the past six months to the tune of Rs500bn (vs Rs1256bn outflows for 2022).

Taking a comprehensive look at the market performance during the past six months, I would draw the following conclusions:

1.    From the sharp outperformance of broader markets it is evident that the sentiment of greed is overwhelming the investors’ fears; and signs of irrational exuberance are now conspicuous.

2.    Most of the good news (rate and inflation peaking; earnings upgrades; financial stability; etc.) is already well known & exploited; while the fragility in global economy and markets has increased and hence the present risk-reward ratio for traders may be adverse.

3.    From a historical relative valuation perspective – Nifty is currently trading at ~4% premium to its 10yr average one year forward PE ratio. The same premium for Nifty Midcap100 is 14%; while Nifty Smallcap100 is trading at ~2% discount to its 10yr average one year forward PE ratio. The discount of smallcap PE ratio to Nifty PE ratio is presently close to 22%, larger than the 10yr average of 16.5%. The sharp outperformance of smallcap may be a consequence of value hunting and irrational exuberance, rather than greed; and the traders may soon return to Nifty as the valuation gap is filled.

In my opinion, therefore, it would make sense to take some money off the table, especially from broader markets and high beta stocks.