Indices may obscure the performance of individual stocks and therefore do not fully reflect stock market corrections
Indices may obscure the performance of individual stocks and therefore do not fully reflect stock market corrections
As headlines lamented a few weeks ago, the Nifty 50 plummeted nearly 5% in one day. After that there were several falls. If you were one of the savvy investors who thought this was a great buying opportunity, you probably would have stopped reading the headline screaming a nifty recovery.
The Nifty 50 is down around 6.4% since its high in October 2021 (as of March 18). So you might now be thinking that the correction is either complete or that it wasn’t deep enough to allow buying at cheap enough prices given the Nifty 50’s returns. But did you know that the Nifty or the Sensex can mask the performance of individual stocks and therefore not fully represent the stock market correction?
Broader correction
The full market cap of the Nifty 50 is about 58% of the market cap of the Nifty 500, which is a better representative of the entire market than the 50-stock index. Thus, while the Nifty 50 may be dominant, there is much outside of this universe of 50 stocks.
Keep in mind that indices like Nifty or Sensex are weighted by market cap, meaning rising stocks get more weight. As such, some stocks may affect the return of the index, even though most other stocks perform differently.
Look at the stocks in the Nifty 500 basket. Almost 60% of them have seen a much bigger price drop than the Nifty 50 since the October 2021 peak. The average drop in stocks is just over 18% — significantly more than the Nifty Index’s 6.4% correction. In other words, a majority of the stocks in the market corrected more than the Nifty. You might not have been looking for stock opportunities if you had just followed the Nifty level.
Most of that, of course, is in small-cap stocks. This is natural as this segment of the market usually takes the brunt of corrections, but this segment also sees far larger rallies. But even outside of small-caps, there are a number of stocks in the mid-cap and large-cap segments that have suffered severe losses.
For example, consider the Nifty 100 Index, which contains the 100 largest stocks by market cap. Nearly half of the stocks in the index have seen larger declines than the Nifty 50, with the average decline being 13%. So there are opportunities to buy fundamentally sound stocks at better valuations, especially given the rapid rally of the past two years.
performance differences
Why doesn’t the Nifty 50 fully reflect the actual decline of individual stocks? This can be explained by a few factors: First, the index is weighted by market capitalization. The return of the Index is therefore dependent on the performance of stocks with larger Index weights and this may conflict with other stocks even within the Index.
As we saw earlier in 2018, the top stock weights that outperform most can pull index returns higher even as other stocks languish. In 2020 and 2021, non-index heavyweight stocks rallied, leading to a broader rally. But now, with six of Nifty’s 10 heaviest weights either up or flat over the past few months, the index as a whole has outperformed individual stocks.
Second, as is typical of any market cycle, some sectors have suffered much more than others. The financials segment is one that has fallen sharply – and while the Nifty has a heavy weight in the banking sector, NBFC and other non-index financials have also fallen. Other sectors that are not index-dominated but have seen selling include chemicals, pharmaceuticals, autos and FMCGs.
A third reason could be passive investment flows. Because passive funds are bound to buy into stocks to reflect the index, index investing and rebalancing could provide support for stocks within the index. So stocks outside of indexes can fall much more sharply without this support. For example, Nifty index funds and ETFs’ assets under management increased by 3.5% between October 2021 and February 2022. Assets under management in active equity funds, on the other hand, shrank by 2% over the same period. AMFI data shows that inflows into index funds and other ETFs (ie non-gold) increased by 50% month-on-month in February 2022, although equity funds saw only a 2% increase.
The upshot of all this is that waiting for a correction from Nifty or Sensex before jumping in can mean missed opportunities in your own portfolio. So how do you stay vigilant and not forget individual stock corrections? A stock watch list can help here.
First, you can do your homework to identify stocks that are fundamentally strong and put them on your watch list if you think they’re expensive. You should do this on an ongoing basis and not when a correction begins. Corrections can give you the buy signal.
Second, you can shortlist stocks from your existing portfolio if they are of high quality and offer an averaging opportunity. This also ensures that you hold more solid stocks, which ultimately helps build wealth. Such a watch list will help sharpen your focus when corrections begin and allow you to buy into attractive valuations even though major market indices have yet to correct.
(The author is co-founder of PrimeInvestor.in)
