Small investors should listen to Sebi chairman’s advice
Retail participation in the stock markets has surged in recent months. With around 3.5 million trading accounts opened in the last four months, retail investors have become a formidable force, accounting for about 75 per cent of the exchange turnover. Securities and Exchange Board of India (Sebi) Chairman Ajay Tyagi noted on Wednesday increased retail participation was not a cause for concern, but the way it was increasing was. Mr Tyagi rightly suggested that the entry should be more gradual and investors should take informed decisions. The surge in the number of new dematerialised accounts and trading volumes in the retail segment could increase risk in the market.
There are reasons for the rise in retail participation. The sharp recovery in the benchmark indices from the March lows is one of them. The benchmark indices have gained over 47 per cent from the lows. Further, returns on fixed-income instruments have come down because of the lowering of interest rates by the Reserve Bank of India to support the economy. In fact, bank fixed deposits are now offering negative real returns. The real estate market is also depressed and activity is unlikely to increase meaningfully in the near term. Thus, given the return prospects in other assets, retail money is being attracted to the stock market. Since equity mutual funds have also given poor returns in recent years, largely because of the poor market performance, a large number of retail investors seem to have decided to invest directly.
Although the Indian stock markets, along with other global markets, have recovered most of the lost ground, the rally has largely been driven by liquidity. Foreign institutional investors have become net buyers since May after selling stocks worth over Rs 58,000 crore in March. But there are plenty of red flags in the market that should make investors wary. For instance, retail investors are flocking to buy stocks not necessarily because they see value but because they want to ride the rally and make quick gains. This tends to push up valuations and eventually results in a major correction. As a matter of fact, valuations have gone up with no earnings visibility. The Nifty50 is now trading at about 29 times earnings, compared with a 10-year average of about 22. The valuations would expand further if the markets continue to rise because the earnings are unlikely to improve soon. Some investors are now factoring in the earnings for the next couple of years, which makes little sense in the present circumstances.
The stock markets are essentially ignoring the economic reality. Before the Covid crisis hit India, the Indian economy was expected to grow by 5-6 per cent. The markets are now moving closer to the pre-Covid levels with contraction in economic activity, which is bound to affect earnings. In fact, with continued rise in Covid-19 cases and signs of faltering economic recovery, growth projections are being revised further down. Rating agency ICRA now expects the Indian economy to contract by 9.5 per cent in the current fiscal year. Since there is significant uncertainty about economic recovery, higher levels in the stock market would become increasingly risky, particularly for the retail investors, as stock prices are not being supported by fundamentals.