To rise from current levels, markets will require an early medical solution for Covid-19, which will allow resumption of normal economic activities. They will need strong earnings in FY22, and steady flows from both local and global investors. (PTI Archive)

Nilesh Shah, Managing Director of Kotak Mahindra Asset Management Co Ltd, has over a quarter century’s experience in capital markets and market-related investments. One of the country’s most astute financial analysts, Shah will regularly weigh in with his assessment of the market and its impact on the economy in this time of uncertainty. He makes sense of the Sensex:

The Covid-19 curve has hardly flattened, the case count is rising, and uncertainty prevails over economic revival with India staring at its worst growth performance in four decades. Despite this, stock markets have rebounded to March levels. What explains this exuberance?

The market always looks at the future. At the current level of the Sensex, the Street is discounting that India will be current account surplus in FY21 due to lower oil imports, lower gold imports, and reduction in imports from China.

The market is pricing in flows from FPIs (foreign portfolio investments) due to increase in India’s weight in the MSCI and FTSE Index. The market is factoring in that fiscal and monetary stimulus announced by the government and the Reserve Bank of India will work in restricting India’s FY21 GDP growth to about – 5%, but will lay the foundation for a strong rebound in FY22 GDP growth. Most importantly, the market is pricing in the resumption of normal economic activities, with a medical solution to the Covid-19 pandemic around the corner. If the actual scenario in coming days is better than what is priced by the market, the index can rise from here. If the actual scenario is worse than what is priced by the market, the index will fall from the current level.

So, would you say there is no divergence between economic fundamentals and market movement?

In the long term, economic fundamentals drive the market. While we see Nifty at 10,302 as on June 30, 2020, the top 15 stocks are trading at a level of 13,890, and the bottom 35 are trading at a level of 7,498. This sharp polarisation is reflecting the market’s belief that the top 15 companies are safe to invest, whereas the bottom 35 companies mirror the scare in the market and the pain of the Covid-19 disruption.

Data show that the growth has not been only in the premier indices; even the mid-caps and small-caps have gained. What are the factors for this broader optimism in the market?

Mathematically when you fall from 100 to 10, it is a drop of 90%. When you bounce from 10 to 20, it is a jump of 100%, even though you are down 80% from the top. Small caps were at one stage down 65% from the top. They had fallen too much, expecting companies to shut down. They have bounced back as their fears have been proven unfounded. Companies have found innovative ways to cut costs and survive the downturn.

Are Indian markets expensive today, especially given that earnings may be a washout in FY21?

It will be futile to value the Indian market currently on the basis of earnings. The Street knows that FY21 earnings will be a washout. One will have to focus on FY22 earnings. It will be better to evaluate equities on market cap to GDP basis. On January 17, 2020, when the Nifty was at 12,000, the market cap to GDP ratio was about 78%, a little above the historical average. On March 23, when the Nifty was at 7,600, the market cap to GDP ratio was about 51%, substantially below the historical average. Today, we are trading at a market cap to GDP ratio of about 72% — almost at the historical average. Markets are fairly valued at the historical average. It is cheap when it trades at a discount to the historical average.

A man walks past the Bombay Stock Exchange in Mumbai. (Express Photo: Nirmal Harindran)

We have seen a large number of new retail investors entering the market directly through stock exchanges. What could be driving this retail investor behaviour?

There are a couple of factors driving retail investors to the stock markets. Many young people have recognised the importance of savings, and would like to invest for a rainy day. Many aren’t able to spend money due to the lockdown and hence have to invest their surplus. Many are sitting at home and have tried to make a quick buck through trading in the stock market. Their participation has increased retail participation in the stock market to one of the highest levels ever.

Many are chasing lower priced shares in the Z group. Their frenzied buying has pushed prices higher, giving them instant gains. This instant success makes them put more money in the market, and also bring their friends and relatives into the market.

The data on volumes in the cash segment shows that non-institutional investors (retail) have increased their share to over a decade’s high of nearly 70 per cent. FPIs and domestic institutional investors (DIIs) have been marginalised.

How do you interpret this trend?

One will have to look at delivery volume rather than trading volume. Undoubtedly, retail participation has increased in trading as well as delivery volume. However, delivery volume is still dominated by institutional investors in the A group of large-cap shares. In the Z group shares, retail investors dominate both the trading as well as the delivery volumes, as institutional investors don’t want to touch them.

In April and May, new SIP registrations averaged 7.8 lakh, an almost 25% fall from the monthly average of 9.8 lakh in FY20. Are retail investors rushing to invest directly? What are the reasons?

SIP returns pale versus returns from direct equity currently. It is but natural that new investors are attracted to direct equity. SIP is sold by thousands of mutual fund distributors through face-to-face connect with investors. With restrictions on movements, that connect is not possible. I am sure SIP will make a comeback to its normal growth path when distributors are able to meet investors on a face-to-face basis.

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Has there been an improvement in terms of fresh inflows into equity mutual funds in June-July?

Equity fund flows have come down from the March highs. While there is some slowdown in gross flows as many investors are waiting for correction, redemptions have increased sharply. Part of the redemptions are to fund financial emergencies due to Covid-19. Part of the redemptions are due to profit booking as markets have rebounded sharply. There will be gradual recovery in flows once investors get confidence about normalcy.

While the gain since the low of March 23 is around 40 per cent, do you see the momentum continuing? What factors could drive the markets further?

For the market to rise from its current levels, it will require an early medical solution which will allow resumption of normal economic activities. Markets will need strong earnings in FY22, apart from steady flows from both local and global investors. The markets will need lower oil prices, a lower trade deficit with China, and lower gold imports to see India becoming current account surplus in FY21. Rising global markets also has a rub-off effect on local markets. Events will decide what course the markets will take.

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What are the downside risks to the market at current levels?

The downside risk to the market will come if the above scenario plays out in the opposite direction. Markets will move in line with how the actual scenario plays out versus what is discounted.

Should retail investors step into the market at such high levels?

Retail investors must not look at market level alone to invest. They must follow a disciplined approach based on their risk profile and investment objective. The guru mantra for wealth creation is regular investment (little drops of water make an ocean), long term investment (you have to wait for 12 years to grow a mango tree) and disciplined asset allocation (maintaining equilibrium is key to success). At the current or any level of the market, investors must stick to its financial plan.

What will be your advice to them?

At the current market levels, I recommend investors to be overweight on gold, neutral on debt and equity, and underweight on commercial real estate. In equity, go for quality, and avoid penny stocks. In fixed income, invest in higher credit quality assets. Avoid under-construction properties from unknown developers in real estate. Sovereign gold bonds will be the best way to invest in gold.

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