2017 was a dream year for global equities in general and Indian equities in particular. However, 2018 seems to be quite different. In recent times, the damage seen in Indian equities has been substantial. This has been especially more prominent since mid-January, when the benchmark indices touched their all time highs. The fall has been even more severe for smallcap companies. The BSE Smallcap index for instance is down by ~15.8% from its all-time high figure.
A more in-depth look at the BSE-Smallcap index further validates this. From the 860 odd stocks that are part of the index, ~85% of them have declined more than this ~15.8% figure from their respective peaks (not necessarily coinciding with the time of the high of the index).
Some other data points:
• Over 77% of the stocks forming part of the index fell more than 20% from their 52-week highs
• ~27% of the stocks fell by more than 40% from their 52-week highs
• Over 11% of the stocks more than halved in value from their 52-week highs
With such declines being seen in stocks of lower market cap companies, the outperformer tag attached to them seems to have fizzled out in recent times.
In FY18, the Sensex, BSE-100, BSE-Midcap and BSE-Smallcap indices rose by 11.3%, 10.6%, 13.2% and 17.6% respectively. However, if we look at data over the past six months, the returns of the Sensex, midcap and smallcap indices have been at par with the indices up by ~6%, ~6% and ~3% respectively. In fact, in the quarter gone by, the Sensex outperformed the other two indices, falling by a little over 3%, while the mid and smallcap indices fell by ~10% to ~12% each.
Moving on to fund flows, it was the domestic mutual funds that took the cake in FY18, with the net inflows into equities standing at over INR 1.2 trillion. FPIs on the other hand invested a net sum of INR 215 billion in the full year FY18, forming only ~17% of the domestic MFs inflows.
In other words, domestic fund flows (and thus household savings) into equities had a strong role to play in keeping the markets firm over the past few quarters. Developments such as demonetization, RERA implementation and other rules & regulations discouraging investment towards other asset classes had a role to play towards more funds being flown towards equities, with the latter asset class being the preferred due to lack of alternatives. Not to forget, interest rates have been at their lowest in many years, not enticing savers to park their money in debt instruments.
This becomes a major factor to take into consideration, as about two-third of Indias gross household savings are parked in physical assets such as real estate and gold. On the other hand, investments towards equities are very low, falling in the mid single digit region.
For market bulls, the argument has been that incremental flows are bound to come in for equities due to the many factors stated above – with the key argument being there is no alternative (TINA). And thus, a slight change in percentage of money moving towards equities (from amount being allocated to physical assets) will turn out to be a substantial figure in absolute terms (given the low base). And this trend is expected to continue, thereby making the case for equities quite strong.
As much as we would like to be on board with this thesis, the fact is that money in India – retail money especially – flows into equities keeping in mind the market sentiments and that too usually with a lag effect. As and when the markets continue to perform better with time, the money inflow only rises.
However, the same holds true in contradictory times as well. When stocks begin to underperform due to various reasons – be it valuations, or a crisis situation – it is only a matter of time before fund flows towards equities start drying up. This is a trend that has been observed in the past, not only in India but globally in almost every market cycle.
And we believe there is no reason for this to change, given the nature of human beings. As and when equities start underperforming or when their performance does not match up to expectations of market participants, flows are bound to dry up and this will impact equities as mutual funds will then not have to deal with the not-so-bad problem of sitting on excess cash that they are facing at present.
As we have been saying for a while now, in our view 2018 is likely to be quite the opposite of 2017, which saw a run up in stocks across the board. This time around, a lot of factors will play their part in testing market sentiments and the endurance levels of market participants. Some of these also include the busy political calendar (state elections and the noise leading up to General Elections in 2019), the emerging inflationary concerns and the expected impact on interest rates, discussion revolving rural income and farmer wages, and the monsoons, among others.
To conclude, wed like to reiterate that it would be wise to keep expectations in check in the medium term, especially for investors new to the equity investing bandwagon.
Be assured that we remain bullish on India and believe that there is no match to equities as a wealth creating asset class. But this view is over the longer term. Short-term blips are bound to make the markets move in a volatile manner, which is something that new investors may have a hard time dealing with.