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What’s worrying the stocks market? Three factors actually

The economy is showing signs of faster-than-anticipated recovery, earnings were robust, institutional inflows are ticking and yet, something is gnawing at the markets.

August 23, 2021 / 07:09 PM IST
After a strong rally for the past 15 months, the broader markets must be feeling some fatigue.

After a strong rally for the past 15 months, the broader markets must be feeling some fatigue.

The month of August has witnessed sharp correction in the broader markets, especially in small-cap stocks, whereas the benchmark Nifty has held up well. In the past couple of weeks in particular, most portfolios appear to have underperformed the benchmark indices.

The fall in broader markets has not been surprising given the sharp outperformance during the February–March period. Nonetheless, the magnitude of the divergence between the broader market and benchmark indices in August must have caught many traders by surprise.

Anecdotal evidence indicates that the erosion in individual portfolios might be significantly worse than as represented by the broader market indices such as Nifty Midcap100 and Nifty Smallcap100.

The correction in broader markets seems counterintuitive.

The overall economy is showing the signs of faster than anticipated recovery; net institutional flows have been positive in August; RBI once again committed itself to growth; the foreign trade data continues to be encouraging; fiscal data continues to be positive; inflation eased to within RBI tolerance range; the rupee remained stable; lending rates were eased in some pockets despite elevated benchmark yields; Q1FY22 results of most lenders have not shown any material rise in stress in the economy due to second Covid wave, so far; most IPOs sailed through comfortably; market volatility mostly persisted at lower levels; the participation of non-institutional investors continued to rise (usually a positive for broader markets); corporate performance has shown improvement in the midcap space; the valuation premium of mid and small cap to benchmark Nifty still showing no signs of “heating”; and the last but not the least, equity flows in the mutual funds were very strong in July.

Close

So what is bothering the market? Is it excessive leverage and tightening liquidity, fatigue, or the uncertainties at various levels? In my view, it could be a mix of all of these three factors.

• The opening of economy and resumption of business may be resulting in diversion of funds back to businesses from stock markets. The demand for liquidity may be rising with the onset of a busy credit season, resulting in pressure on leveraged position in stock market.

• After a strong rally for the past 15 months, the broader markets must be feeling some fatigue.

• Multidimensional uncertainties like the monetary tightening by US Federal Reserve and RBI; likely impact of the anticipated third wave of Covid19 in India; repercussions of geopolitical situation due to the developments in Afghanistan; how the commodity and energy inflation will impact the competitiveness of the smaller companies; the impact of erratic and deficient monsoon on rural sector growth and overall consumption demand.

Under these circumstances, the pertinent question is, “what should be the course of action for the investors?”

Is the recent correction a good opportunity to increase the exposure to mid and small-cap stocks? Yes, one may rebalance the portfolio to achieve the pre-determined allocation to mid and small-cap stocks.

Should one be taking leveraged positions in beaten-down mid and small-cap shares to take advantage of the rebound? No, leveraged positions in mid and small-cap stocks are not advisable for common investors.

Should one be taking concentrated position in few mid and small stocks or invest through well diversified mutual funds? It is always better to invest in mid and small cap stocks through well diversified mutual funds, since besides minimising the company specific risks, the mutual funds provide easy entry and exit.

This is very critical since these stocks usually have a tendency to become highly illiquid on both extremes and are often locked at daily trading price limits.
Vijay Kumar Gaba is Director, Equal India Foundation.
first published: Aug 23, 2021 07:00 pm

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