An investor generally gauges the strength of the market by looking at where the indices stand with respect to a reference point which is generally the 52 week high or 52 week low. While there is nothing wrong in this methodology, the error of judgment can crop up from the composition of the index.
Though there is a feeling of gloom in the market, indices do not reflect so. Markets are still within 10% of the year’s high and 12% of its all-time high level. On a year to date basis, Nifty has lost only 6.29% of its value and 4.6% in a month and 3.7% in a week.
However, looking at the individual components of index shows a different picture. In the case of BSE Sensex, only 7 of the 30 stocks are within 10% of their 52 week’s high. In fact 14 stocks (nearly half the index) are within 10% of their 52 week’s low. This inherent weakness of the market is not captured in the index print. The stocks that are near the highs are from the IT, pharmaceutical and the index heavyweight, Reliance. These stocks account for nearly 30% of the index.
Similarly in the case of Nifty, 26 stocks are within 10% of their 52 week low, while 7 stocks are within 10% of their highs.
Indices are calculated using free-floats of stocks in the market and weightage are assigned after based on the individual stock’s contribution to the index. It is natural that bigger companies will be carrying more weights.
In the case of Sensex top 7 companies account for 57% of the index’s market capitalisation. In other words, only 23% of the companies comprise 57% of Sensex. While in the case of Nifty, 8 shares (16% of the number of shares in the index) account for 63% of the market capitalisation.
Market indices like government’s poverty numbers are not capturing the inherent weakness in the market. But that is the nature of the beast; the scientifically designed indices have misled investors to believe that the markets are doing well. As with the case of poverty line the rot is much deeper but is hidden in statistics.