Indices can hide performance in individual stocks and therefore do not represent a complete correction in the stock market.
Indices can hide performance in individual stocks and therefore do not represent a complete correction in the stock market.
As the headlines hit a few weeks ago, the Nifty 50 fell almost 5% in a day. After that there were many declines. If you were one of those shrewd investors who thought this was a good buying opportunity, you might have stopped reading the headline screaming about Nifty’s recovery.
As it stands, the Nifty 50 is down around 6.4% since its high in October 2021 (as of March 18). So, now you might think that the correction has either been done, or that it is not deep enough to allow buying at cheap enough prices, given the returns of the Nifty 50. But do you know that Nifty or Sensex can affect performance in individual stocks and hence does not represent a correction in the stock market as a whole?
comprehensive reform
The absolute market capitalization of Nifty 50 is approximately 58% of the market capitalization of Nifty 500. The latter represents the entire market better than the 50-stock index. So, although the Nifty 50 may be dominant, there is much more outside this 50-stock universe.
Remember that indices like Nifty or Sensex are market-cap weighted, which means that the stocks that rally get more weight. Therefore, some stocks can affect the index’s returns, while most other stocks perform differently.
Consider the stocks of Nifty 500 basket. Nearly 60% of them have seen a much steeper fall in prices than the Nifty 50 since its October 2021 peak. Average fall in stocks is a good 18% – much higher than the Nifty index’s correction of 6.4%. In other words, most of the stocks in the market fell more than the Nifty. If you had only followed the levels of Nifty then you would not have looked for opportunities in the stock.
The bulk of these are in small-cap stocks. This is natural, as this market segment usually bears the brunt of the correction, but again, much larger rallies also take place in this segment. But apart from the small-cap, mid-cap and large-cap segments, there is a good smattering of stocks, which have seen huge declines.
For example, consider the Nifty 100 index, which consists of the 100 largest stocks by market cap. Nearly half of the stocks in the index have seen a sharper decline than the Nifty 50, with an average fall of 13%. Therefore, opportunities are opening up to buy fundamentally stronger stocks at better valuations, especially given the rapid rally over the past two years.
performance difference
Why does Nifty 50 not fully reflect the actual decline in individual stocks? This can be explained by a few factors: One, the index is weighted by market cap. The returns of the index therefore depend on the performance of stocks with heavy index weighting and may be skewed to other stocks within the index as well.
As we saw earlier in 2018, the best-performing top stocks can outperform a weight index’s returns, even when other stocks are underperforming. In 2020 and 2021, stocks outside the index heavyweights rose sharply and had a more broad-based rally. But now, with six of the Nifty’s top 10 heaviest weights either rising or holding steady over the past few months, the index as a whole has outperformed individual stocks.
Two, some sectors have suffered more than others as in any market cycle. The financial segment is the one that has seen the steepest fall – and though the banking sector is heavily weighted in the Nifty, NBFCs and other financial stocks that are not part of the index have also sunk. Similarly, other sectors which are not index-dominant but have witnessed selloff include chemicals, pharma, auto and FMCG.
The third reason could be passive investment flows. Since passive funds essentially buy into stocks to reflect the index, index investing and rebalancing can increase the shares within the index. Without this support, stocks outside the indices may fall further. For example, the AUM of a Nifty index fund and ETF grew by 3.5% between October 2021 and February 2022. On the other hand, the AUM of active equity funds declined by 2% in the same period. AMFI data shows that index funds and other ETFs (i.e. not gold) rose 50% in February 2022 as compared to the previous month, while equity funds saw a growth of just 2%.
The result of all this is that waiting for a correction in the Nifty or Sensex before going ahead could mean missed opportunities in your own portfolio. So how do you stay alert and not be oblivious to individual stock corrections? Having a stock watch list can help here.
One, you can do your homework of weeding out fundamentally strong stocks and put them on your watch list if you find them expensive. You should do this on an ongoing basis, not just when the improvement begins. Corrections may prompt you to buy.
Two, you can shortlist stocks from your existing portfolio if they are of quality quality and offer an opportunity to average. This will also ensure that you have more robust stocks, which will ultimately help in building wealth. This type of watchlist helps you sharpen your focus when corrections begin, allowing you to buy at attractive valuations even when major market indices are still not correct.
(The author is the co-founder of PrimeInvestor.in)