Ask five experts on the market, and all five will agree that the market needs healthy corrections. But the market is in no mood to listen to experts. It’s defying gravity. India’s market cap touched all time high and closed at Rs 388 lac crore by Feb end.
One can understand if the situations improving justifying higher stock indices, but that’s not the case. The expectation of rate cuts since last quarter of 2023 was one of the major reasons the stock indices moved up, but there are now enough indications that the Fed will not cut interest rates until June. At the beginning of the year, there were expectations that there would be seven rate cuts in 2024 from the Fed, but now that hope is reducing, the guess is between 3 to nil. The situation has not improved in the Russia-Ukraine war or the Israel-Hamas war. The shipping companies are taking longer routes and charging higher freight again, creating a supply shock for the world economy. Freight costs have moved by almost 100 per cent, which could push prices higher, in turn pushing Inflation higher and, in turn, postponing rate cuts. India is facing El Nino impacts, which will impact food grains productions and limit the income of the rural economy. Neilsen came out with a report suggesting that FMCG value growth will be lower in 2024 compared to 2023. The consumption cycle has taken a beating, which could impact consumer-facing companies’ margins.
But this news has no impact. The market has got Teflon coating where no negative news sticks. If some news pulls down the indices, it’s just for the day, and the next day market moves up.
We have seen that the Teflon effect does wear out. One can’t be precise when the Teflon effect will wear off, but we want it to happen sooner rather than later. The longer delay means sharper corrections later that may spoil the market sentiments. As we mentioned in our last blog, India’s valuation is commanding an all-time high. The Market cap to GDP ratio is at 130%. Based on the India Inc December quarter numbers TTM price to earnings ratio is at 26x. This kind of rich valuation means we need strong earnings growth. Commentaries from India Inc. are not subdued, but few are confident they can grow their bottom line by 26 percent. We are certainly trading at a premium.
Small caps are under pressure.
Mid and small caps did extremely well in 2023. They extended their performance in January 2024 too. But pressures are building up in the small caps stocks. While large caps and Mid caps closed in the green, small caps declined in February. Clearly, small caps are finding it tough to hold on to their gains. SEBI also feels that many small-cap companies are running ahead of the fundamentals. SEBI advised Mutual funds to do stress tests of the Mid and small-caps schemes. Many of the Mutual fund schemes own a substantial portion of the company’s free float. For some reason, if the scheme decides to liquidate, SEBI wants to understand how many days it will take and what could be the impact cost. The logical argument suggests that many of the NAVs that have been shown may not realise if a mutual fund decides to exit from the small caps due to higher impact cost. The way small caps are behaving does give an impression that fund managers are reducing or reshuffling their small cap exposures.
Large caps are more resilient
In our PMS, we had higher exposure to the small and Mid. Our IP guided us to move away from small caps and park funds in the large caps. In February, we did two things- first, we moved out from small caps (a very small portion now in small caps), and we locked in profits in the Mid-caps. The proceeds have moved into large caps. Today, our PMS schemes have the highest exposure to large caps where risk-reward is better. Based on our IP guidance, we will reshuffle our large cap position in favour of the Mid and small caps some where in later part of the year. Mid and small caps will generate the highest returns in the medium to long term, but the challenge is to navigate short-term volatility.
Retail investors frenzy
Retail investors are in hyperactive mode. This is reflected in the cash volume on the NSE, which is in excess of Rs 1 lac crore daily three months in a row. This is another record. The quick, rich ambition drives the volume on the bourses, which is another sign of danger. Investors who joined the post covid have yet to experience major corrections. If the market corrects, it will be a rude shock, and many of them may be unable to navigate the corrections. We advise investors to apply caution while trading Mid and small-cap stocks.
What to expect going forward
The election schedule will be announced in the next ten days. Till elections are over, there will not be policy actions. The market has assumed that the BJP will have a hat trick which no party has been able to manage since 1971. Until the election results, the market will take cues from Inflation and geo-political situations. As we mentioned in the last blog risk reward is not favourable. We advise extreme carefulness with stock selection. The market upside from this level is capped. Caution is the name of the word. Be fearful than greedy.