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Market Sentiment Has Transcended From Risk Off To Risk On

Market Sentiment has transcended from Risk off to Risk on

India has voted for a decisive mandate which has been welcomed by the market with cheer. We saw a strong pre-election rally and the strong mandate carried the NIFTY to its all-time highs. The market was hoping for a stable government and continuity of policy. For equities as an asset class a stable government has always heralded an increase in risk on appetite among investors. We saw that in 2014, when small cap stocks went thru the roof along with a broad basing of market movements and a big shift from risk off to risk on. We expect a similar phenomenon to transpire and we are already seeing a hint of the same.

Rally in Non Nifty stocks giving the first indication

A study on the volume action and price action of non-nifty stocks are indicating that the market is willing to look beyond the select mega caps and the risk profile of market participants might be changing.  Interestingly in the past few days the volume of midcaps as a percentage of total NSE volumes has risen sharply and is currently accounting for more than 50% (after dipping down to 37-38% recently). Generally when risk appetite is low the NIFTY stocks forms majority of volumes as evidence much thru 2018 where they accounted for nearly 60% of NSE volumes. However, when the risk on sentiment returns, this trend has reversed. For eg, NIFTY volumes to total NSE volumes kept declining from 46.9% in 2014 to 38.6% in 2017 when mid-caps ruled the roost. Hence, the market preference towards mid cap is usually a feature of bullish sentiments and suggests a stance by investors towards riskier assets.

Also, Sectors that have been beaten down for years have started heating up, For eg the NIFTY Reality sector which has been down for 10 years has risen 22% since Feb lows and the NIFTY PSU index has moved 31% from its Feb lows.  Moreover, number of stocks recovering from their recent lows, have displayed its fastest ever rise above 20-DMA since January 2017.  This is another signal of some aggression to buy and perhaps attests to a large amount of money waiting in the wings to be deployed into the market. So far the market was dominated by a few stocks and now we are seeing the rally become more broad based. Hence,

Gradual Mean reversion will ensure Midcap out-performance

The mid and small cap universe have had a huge under-performance compared to large caps.  In the midcap space, stocks are still trading up to 83 per cent lower from their 52-week highs. The valuation differential also is hitting historical highs. The Midcap forward PE, which is currently trading at a 19% discount to NIFTY forward PE, is moving towards historical extremes and eventually it will have to mean revert.

The mid cap index to Nifty ratio is at 1.5, the last time we witnessed these levels was in 2005.

Similarly, The Small cap index to Nifty ratio is at an abysmal 0.5

Both these ratios are well below the 15 year average and have moved into very extreme zones. Prices will not sustain at such extremes for long and will eventually have to mean revert and  once the mean reversion process begins we will start witnessing a catch up trade in these counters and that will create the bouts of momentum that can be grabbed.

Pace of equity inflows to increase

Equity inflows into the markets will definitely see a significant increase in the coming months. As I stated in my last article, FII flows will continue to increase, Domestic institutions who were net sellers will also start going long. Since the election uncertainty h as ended and we have clear road ahead, the pace of SIP and mutual fund flows into the market increase. As incremental bunched up domestic flows that were sitting on the sidelines will be unleashed in the market. Case in point would be the recent MSCI rejig which the market gobbled up in one day. Passive FII outflows have been replaced by active FII inflows and DII inflows.

Retain bias towards Midcaps, albeit with a balanced approach

Opportunities will arise in various pockets of the market, a decline in oil prices and INR appreciation can benefit OMCs who gain from lower under recoveries and manufacturing companies that get a fillip in the form of lower input cost inflation. Through these letters we have been urging our investors to increase allocation towards midcaps. We believe there must be a balanced approach as both types of flows will enter the market I.e. retail and institutional flows. This will create momentum breakouts in many stocks that investors can use to profit from. Our Property investment model is built to take advantage of these factors and investors can reach out to Plus delta portfolios to gain from these investment themes.

Regards,

Aditya Iyer
Fund Manager – Plus Delta Portfolios

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