More hype than substance

Markets' dizzy heights point to short-term blips

The Nifty created history last week by moving past 10,000 on the back of concerted buying from every class of investor. Foreign portfolio investors (FPIs) continue to be attracted to the story of an economy that is undertaking reforms such as the goods and services tax (GST) and the new bankruptcy law. Domestic institutional investors (DIIs) have pumped money into equity. While the DIIs have bought a substantial Rs 48,101 crore between July 1, 2016, and June 30, 2017, and the FPIs have invested nearly Rs 55,000 crore during the same period, their enthusiasm has been dwarfed by that of retail investors. There has been a surge in the allocation of household savings to equity. Mutual fund folios have grown by 9.3 million in the last 12 months, rising to a record 58.2 million folios by end-June 2017. There are more than 14.5 million active Systematic Investment Plans (SIPs) and Equity Assets Under Management (including assets under management of equity funds, equity-linked savings schemes, and exchange-traded funds) have risen by Rs 1.9 lakh crore. Retail investors have directly invested even more. A recent survey of 300,000 individuals indicates that 84 per cent of investors directly buy equity while only 59 per cent invest via mutual funds.

There are several reasons for the rising retail interest. For one, other asset classes appear unattractive. Falling interest rates have meant lower returns from debt; gold is suffering from low global prices, and the real estate market has slowed due to demonetisation. As the consumption story has also taken a break after demonetisation, households have deployed their savings in equity. Most importantly, there has been a positive feedback loop as well. The Nifty has shot up by over 16 per cent in the last 12 months as money has flooded in. Midcaps have done even better with the Midcap Index up by a stunning 32 per cent. Inevitably, capital gains have created a wealth effect and even more retail savings are finding their way into the stock market in the hope of quick returns. 

However, this bull run has been based more on hope and hype than on fundamentals. Earnings have not grown at a commensurate pace. The last two quarters saw a slowdown due to demonetisation. The GST will also have a disruptive impact, which means that earnings growth may take a while to accelerate. Valuations are at alarmingly high levels, with the Nifty trading at a price-earning (PE) ratio of 25-plus and the Midcaps trading at over 35 PE, giving rise to concerns of an equity bubble. While the GST should lead to eventual gains, the initial impact is likely to be negative. 

Indeed, analysts tracking key sectors such as automobiles and fast-moving consumer goods (FMCG) have issued warnings about the negative trends on profitability in the short term. One of the cornerstones of prudent investing is to divide assets across multiple classes. This ensures there is no over-dependence on any one asset class. At the moment, the retail investor is heavily overweight in equity and, therefore, very vulnerable to a setback in stock markets. Prudent investors should consider reducing their equity exposure and reshuffling portfolios, in order to deploy more resources to other assets. Otherwise, the next bear market could take the savings of many households down with it.