As the headlines bemoaned just a couple of weeks ago, the Nifty 50 crashed almost 5% in a day. There were several falls thereafter. If you were among the astute investors who thought this was a great buying opportunity, you would have stopped likely when you read the headline screaming a Nifty recovery.
As it stands, the Nifty 50 is down roughly by 6.4% since its high in October 2021 (as of March 18). So, you may now think that the correction is either done, or that it hasn’t been deep enough to allow buying at cheap enough prices, going by the Nifty 50 returns. But did you know that the Nifty or the Sensex could mask performance in individual stocks and therefore does not entirely represent the correction in the stock market?
Wider correction
The full market capitalisation of the Nifty 50 is about 58% of the Nifty 500’s market capitalisation. The latter represents the whole market better than the 50-stock index. Therefore, though the Nifty 50 may be dominant, there’s plenty outside this 50-stock universe.
Remember that indices such as the Nifty or Sensex are market-cap weighted, which means rallying stocks receive more weight. Therefore, a few stocks can influence the index’s returns even as most other stocks perform differently.
Consider the stocks in the Nifty 500 basket. Close to 60% of them have seen prices decline much more than the Nifty 50 since the October 2021 peak. The average decline in the stocks is a good 18% — much higher than the Nifty index’s correction of 6.4%. In other words, a majority of stocks in the market corrected more than the Nifty. You may not have looked for stock opportunities if you had only followed the Nifty level.
The bulk of these, of course, is in small-cap stocks. This is natural, as this market segment usually bears the brunt of corrections but then, this segment also sees far bigger rallies. But even apart from small-caps, there is a good smattering of stocks in the mid-cap and large-cap segments that have seen steep falls.
Consider the Nifty 100 index, for example, which houses the 100 largest stocks by market cap. Close to half the stocks in the index have seen steeper price dips than the Nifty 50, with the average decline coming in at 13%. So, opportunities to buy fundamentally sound stocks at better valuations, especially given the rapid rally over the past two years, are opening up.
Performance differentials
Why does Nifty 50 not entirely reflect the real fall in individual stocks? This can be explained by a few factors: One, the index is weighted by market caps. The index’s return is therefore dependent on the performance of stocks with heavier index weights and this can be at odds with other stocks even within the index.
As we saw earlier in 2018 too, the top stock weights doing better than most can pull up the index’s returns even as other stocks languish. Over 2020 and 2021, stocks outside the index heavyweights climbed sharply bringing about a more broad-based rally. But now, with six out of the Nifty’s top 10 heaviest weights either gaining or staying flat in the past few months, the index as a whole has done better than individual stocks.
Two, some sectors have suffered far more than others as is typical in any market cycle. The financial segment is one that has dropped heavily – and though the Nifty has a heavy banking sector weight, NBFC and other financial stocks that are not part of the index have also sunk. Similarly, other sectors that are not index-dominant but have seen selling include chemicals, pharma, auto and FMCGs.
A third reason could be passive investment flows. As passive funds need to necessarily buy into stocks to reflect the index, index investing and rebalancing could shore up stocks within the index. Stocks outside indices, without this support, can thus fall much more. For example, the AUM of Nifty index funds and ETFs rose 3.5% between October 2021 and February 2022. The AUM of active equity funds, on the other hand, shrank by 2% in the same period. AMFI data shows that inflows into index funds and other ETFs (i.e., not gold) jumped 50% in February 2022 over the previous month, even as equity funds saw just a 2% rise.
The upshot of all this is that waiting for the Nifty or Sensex to showcase a correction before wading in may mean missed opportunities in your own portfolio. So how do you then 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 filtering out stocks that are fundamentally strong and put them in your watch list if you find them expensive. You should do this on an ongoing basis and not when a correction starts. Corrections can give you the buying signal.
Two, you can shortlist stocks from your existing portfolio if they are quality ones and provide an opportunity to average. This will also ensure you hold more of sound stocks, which will ultimately help build wealth. Such a watch list helps sharpen your focus when corrections begin, letting you buy into attractive valuations even though the main market indices are yet to correct.
(The writer is Co-founder, PrimeInvestor.in)
