Can retail investors sustain the market rally? – The Hindu BusinessLine

lipped from: https://www.thehindubusinessline.com/opinion/columns/can-retail-investors-sustain-the-market-rally/article34599409.ece

WIDE

They do not have the fire-power. The rally can be sustained only if the pandemic is contained fast and FPIs/MFs resume buying

Foreign portfolio investors have acted as the main pillar supporting the Indian equity market since 2000, pumping in money year after year, with rare exceptions. Mutual funds have emerged as another important source of liquidity since 2014, as Indian investors adapted to this vehicle to invest in stocks.

Equity oriented mutual funds, that had been reeling under sustained net outflows until February, have not been able to bridge the gap left by FPI outflows. They have net sold ₹484 crore in May following net purchases of ₹5,526 crore in April 2021.

Despite the two large groups of institutional investors reducing their purchases, the Nifty 50 has been reasonably steady, currently at just 2 per cent below its life-time high. This resilience is largely due to individual investors who have emerged as the third pillar or support for the stock market.

The problem however is that retail investors are less informed and have lower capital when compared to institutional investors. Therefore the ongoing rally can be sustained only if the pandemic is contained fast, vaccination is accelerated and FPIs and MFs resume buying Indian stocks.

Analysis of shareholding

An army of new investors entered the Indian stock market in 2020 as the Covid-19 induced lockdown increased the free time available to people working from home. NSDL and CDSL added almost 1.02 crore new accounts last year.

But the issue is that most of these first-time investors have been viewing the stock market as a source of entertainment, to escape the boredom of confinement at home. They have been mainly trading or indulging in short-term investing. This can be inferred from two data points — retail shareholding in listed stocks and their share in daily turnover.

If the ownership pattern of NSE listed companies, based on total market capitalisation, is considered, private promoters held 44.3 per cent, foreign portfolio investors 21.7 per cent and retail investors 9 per cent stake towards the end of December 2020.

Now, retail shareholding is divided into HNI holdings (investors holding more than ₹1 lakh in a stock) and retail investors (holding less than ₹1 lakh). The share of retail investors has increased from 6 per cent in December 2019 to 7 per cent by December 2020 while shareholding of HNIs remained static, at 2 per cent. So smaller investors have been increasing their exposure to stocks over the past one year.

Analysis of stocks where retail investors have increased stakes in 2020 shows that they have been making wrong choices, chasing stocks with weak fundamentals. Future Retail, Future Consumer and Indiabulls Housing Finance top the list of stocks favoured by these investors. Of the top 10 stocks that have recorded sharp increases in retail shareholding in 2020, eight have witnessed erosion in market capitalisation in 2020.

Many retail investors are also trading heavily in both the cash and derivative segments of the stock exchange. The share of individual investors in cash market volume increased from 39 per cent in FY20 to 45 per cent in FY21. They have also grown their share of turnover in index and stock futures and options.

It is therefore hard to expect retail investors to provide the fire-power to take stock prices higher in the coming months. Most of the new set of investors do not have deep pockets and are using trading margins that allows them exposure that is many times their capital. If stock prices begin falling, such positions will have to be unwound to meet margin calls, exacerbating the fall.

Market conditions unfavourable

Also, despite rosy prognosis of market experts, it is clear that the rally in Indian stocks is on a wing and a prayer now. The second wave of Covid has placed India in a very unfavourable position when compared with other countries. With fatalities continuing to mount and lockdowns expected to continue until June, it is clear that the growth in the first quarter of FY22 will be hit. This is going to impact corporate bottomlines too.

In contrast, the recovery is quite strong in the US, the UK and other advanced economies. Foreign investors are likely to prefer these markets, at least in the immediate future.

Domestic conditions are not too favourable with the ongoing lockdowns impacting consumption demand negatively. With the threat of third wave growing, a revival in demand akin to last year may not be easy. Rising commodity prices and inflation are likely to hurt margins further. Despite all this, stock prices are at historic highs, making valuations extremely pricey, higher than the 2007 levels. With earnings de-rating likely in the coming months, the rally is on shaky foundation.

Will FPIs return?

However the new investors who entered stock market last year have seen just one market cycle and will be more susceptible to believing that the rally will go on. In a typical bull market, the informed investors enter the first phase when smaller investors are still selling. The second phased is broad-based with smaller investors too joining the party. In the third and final phase, the informed investors exit while retail investors continue buying.

The ongoing phase reeks of a final phase of the rally from the March 2020 lows. It may be recalled that conditions were similar in the last quarter of 2007, when the rally was prolonged by retail investor buying, only to be followed by one of the worst crashes in recent history.

Unless buying by FPIs and MFs resumes, once the second wave abates, it may not be possible for the rally to continue. Investors need to pay greater attention to asset allocation, spread savings across fixed income, equity and gold. Diversification in the form of international investing is also a good idea under these conditions.

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