After skipping their breakfast meetings for many weeks, Muthu (a retired finance professional), Sridevi (financial adviser) and KK (a stock trader) decided to meet up for an evening snack at Shree Mithai House.
Muthu and KK arrived first and had placed orders for Kesar Badam milk when Sridevi rushed in with a hassled air. “Cool down, Sri, and have some of this. What has gotten you so hot and bothered,” asked Muthu.
They order Tokri chats and Paneer Pizzas.
Muthu: What market crash? My Nifty50 index fund is up one per cent.
Sridevi: The Nifty and Sensex are poor indicators of what’s happening with retail portfolios. Look at the Nifty Midcap and Smallcap indices. They’ve lost 15-20 per cent in the last six months. In fact, I was just looking at NSE-listed companies and found that over 120 stocks have tanked 50 per cent in the last six months. Some popular stocks have tanked 70-80 per cent and my clients own them.
KK: Good thing no. Now they don’t have to worry about grandfathering benefits or capital gains tax for their IT returns. They’ll have only capital losses, he-he-heh .
Sridevi gave him a nasty look. “Nice to see you taking such a humorous view of the situation, KK. Didn’t you make losses?”
KK: I trade the Nifty only, sister and don’t do small- or mid-caps. Their volumes dry up the moment bears arrive. I prefer stocks where the big boys, the FPIs (foreign portfolio investors), like to play.
Muthu: I don’t understand this. FPIs have sold only ₹5,500 crore worth of Indian stocks in 2018. That’s chickenfeed compared to the ₹53,000 crore they dumped in a bear year like 2008. So why are these stocks dropping like there’s no tomorrow?
Sridevi: Well, I can explain that. Mutual funds have been engaged in a Samudra Manthan of their portfolios in the last six months. Earlier, mutual fund mandates were quite vague and equity funds were free to chase after ‘alpha’ by investing aggressively in mid- and small-cap stocks. But in October, SEBI asked all funds to align more closely with their stated mandates. It also defined the top 100 stocks as large-caps and the next 150 as mid-caps. This has forced fund managers to shift about ₹45,000 crore worth of assets from one bucket to another.
Muthu: Aha, that explains the schizophrenic market. Large-caps are probably better off because they feature more foreign investors. FPIs own 22 per cent in the top 100 stocks while domestic institutions own just 11 per cent. If you go beyond the top 100 though, domestic institutions nearly match foreign ownership. So, mid-cap stocks must have been hit both by your Samudra Manthan and FPI selling, poor things.
KK quipped: I can’t let mutual fund managers take all the credit, boss. My trader friends squarely blame the stock exchanges for suddenly sweeping 109 stocks into ASM (Additional Surveillance Measures) in June. You’ve now got to pay 100 per cent margins to trade on these stocks and they are stuck in a 5 per cent price band. That’s taken all the excitement out of punting on fun stocks such as Usher Agro, Jaypee Infratech and Electrosteel Steels. Once a stock is in ASM, day-traders flee it. Weaker hands (aka retail investors) also rush for the exit door. I bet that’s why you’ve seen 40 to 50 per cent price falls.
Sridevi: It’s not just about penny stocks. My clients are asking me why Rain Industries, Graphite or Prakash Industries are on that list. I tell them that stocks in the ASM list aren’t necessarily bad and that the exchanges simply put highly volatile stocks under ASM. But many investors bought these stocks because they’re owned by RJ, DK, PV and other big market names.
Muthu: Sri, you should advise clients against such copycat strategies. Large investors may announce it with a loudspeaker when they are accumulating an obscure stock. It helps bid up demand. But they’ll seldom broadcast their sells or tell you why they bought it. This is a good move by SEBI. Forget your trader chums, KK. Think of newbies buying stocks based on SMS or Twitter tips. Good thing SEBI stepped in now. Retail investors should buy stocks if they can do their homework on fundamentals. Or leave it to mutual funds.
KK: Personally, boss, I’m very sceptical of ‘fundamentals’ and how fund managers measure them. Take this Manpasand Beverages. It was recommended as a ‘quality’ FMCG play and shot up from ₹160 to ₹480 over two years. But just because its auditor bid goodbye, it is now back to ₹148. It tanked 40 per cent in two days. What has changed about its fundamentals? Nothing! It has reported a 38 per cent profit growth. Ditto with Vakrangee with a 30-per-cent EPS jump. Six months ago, it was at ₹420, now it is struggling at ₹55.
Muthu: You’re dead wrong there, KK. When the auditor of a company resigns mid-term, that’s a red flag to investors that all is not well with the reported numbers. Once there are doubts around this, there’s no way the market can realistically value the stock. The price fall then has everything to do with fundamentals. It’s a question of a company losing credibility and facing a PE de-rating.
Sridevi: I heard that the recent spate of auditor exits is because of the government tightening the screws on them. If the numbers happen to be dressed up, statutory auditors may no longer get to do a Satyam and claim they were bamboozled by the management.
KK: Investors have become suspicious of other corporate actions too. Deferred buybacks, cancelled dividends and promoter pledges are all seen as signs of window-dressing.
Muthu: I would say the scepticism is very welcome, KK. For the last four years, retail investors and even fund managers, have been far too willing to swallow all kinds of fancy growth estimates for companies with a limited track record and give them a sky-high valuation. Tell me seriously. Don’t you think a PE of 68 is fizzy for a fruit drink maker? Must you pay 70 times for a company running Aadhaar kendras when TCS is available at one-third that valuation? Even if the profits for these smaller companies continued to grow, there was a case for much lower PEs.
This holds true for the entire mid-cap basket. In 2013, the Nifty Midcap index was trading at a 12-13 PE while the Nifty50 was at 15-16. The discount is normal given that smaller firms face higher business risks. But the mid-cap bulls turned this logic on its head. Now the midcap index is at a 40 PE and the Nifty50 is at 22. I would say its good that this bubble is popping before it exploded in our faces.
Sridevi: Yes, I’m beginning to see the silver linings in this mid-cap storm. That’s brought my appetite back, so let me finish up that dosa.