Dear Clients,
This is the continuation of my previous post where I discussed my views on the current market situation. As we know, markets are a function of 3 things. A) Valuations, B) Liquidity, and C) Sentiments. In my previous post I briefed about my views on valuations and liquidity. In short, valuations are not cheap across the board (especially in small and mid-caps) and while liquidity (global) has been buoyant, I feel eventually it will taper off. This makes me cautious on the markets. What worries me, and more so from an Indian context is the current sentiments. Let’s look at some numbers and developments.
- In absolute terms, options trading is at its highest in the history of Indian markets (more than 6 lakhs crores).
- MSCI India Small Cap is trading at a 33% C 129% premium to MSCI US Small Cap C MSCI China Small Cap respectively.
- Currently the largest equity mutual fund scheme is a mid-cap scheme from HDFC at roughly 60,000 crores.
- Highest incremental money has come to small cap schemes in 2023.
- SEBI and AMFI have asked mutual fund companies to safeguard investors if large redemptions hit their small and mid-cap schemes.
- Some mutual fund companies have stopped taking fresh lumpsum in their small cap schemes.
The above-mentioned pointers are some facts that I have been observing for some time. Along with this, there is a clear euphoria in the SME and Small cap segments of the market. We hear people seriously thinking of quitting their jobs and becoming full time traders. 10-year, 15-year rate of return assumptions are in the range of 25% and 30% compounded annually. Doubling of share prices in a year or two is considered normal or somewhat “thik thaak” return, etc. We have seen these behaviour traits in 2006-07, 2014, and 2017. We also know what happened subsequently.
The problem with euphoric sentiments is, it is really hard to control them when everything is going up. In my observation, there are 2 reasons for this. 1) the observed rates of returns are very high for the recent past and hence it is easy to believe and extrapolate the same returns for the longer periods, and in theory becoming “rich” in the not-so-distant future through stock markets, and 2) the attention span or the psychological holding period of investors shrinks from years to months to days as the bull run progresses. You can literally hear people saying that they have bought a share, and nothing has happened. Bought since when? Bought since “Diwali”. 3 mahina ho gaya Nishith bhai, sala hilta hi nahi hai. Eventually people become habituated to check their portfolios daily, compare it with their friends and relatives and recent past, discuss markets in social functions, etc.
Of course, if you have seen more than 2 cycles in the markets, you would know the above factors are not clear signs of a crash. It is impossible to predict market top or bottom. What it means is, there is a blatant disregard for risk by market participants when it comes to small-cap and micro micro-cap companies. Future returns, even if they are decent relative to other asset class, will not be as enticing as they have been in the recent past. Investors should re-look their portfolios and trim their exposure to high-risk segments of the markets.
What should investors do?
- Re visit your equity portfolios and trim down your exposure to small and micro-cap companies to more manageable levels depending on your risk-taking ability.
- Incremental investment should be invested in a staggered manner and should go towards large caps and high quality medium and small caps.
- If you are trading in futures and options, please make sure that you understand the risks involved in them. Please assess the possibility of loss of capital and do not overexpose your capital to these instruments.
- Remember, volatility and risk are features of the markets and one should think that they are always around the corner.
- Investing is not about “not taking risks”, rather it is about “managing the risks well.”
- Keep your expectations reasonable and investment horizon long.
Please feel free to contact me in case of any queries.
