A decade lost! Retail investors likely to re-evaluate their risk profiles after recent selloff

In the last decade, we have seen an extremely low-interest rate environment which drove down the cost of capital and led to expansion in price earnings (PE) multiples for numerous stocks.

Moreover, the lack of yields on fixed-income instruments has forced many retail and first-time investors who are traditionally low-risk investors to invest in the stock markets at frothy valuations.

We have seen record retail inflows into the stock markets by many first-time investors who probably don’t understand risk associated with the stock markets.

Nearly 1 out of 4 stocks in the BSE500 have already lost more than 50 per cent and the bear market has already started in some of the sectors.

As interest rates rise in the cost of capital will increase and the froth in stocks will correct even more. We have already seen central banks across the world taking measures to curb inflation by tightening the money supply.
The Reserve Bank of India (RBI) has increased the repo rate by 90 basis points which will lead to a flow of liquidity from the markets to the central bank chest.

The central banks are way behind the curve and given the fact that global inflation is still running hot, we see more rate hikes by central banks going forward.

Given foreign portfolio investors (FPI) outflows and what is happening with our neighbors (Sri Lanka, Pakistan, Nepal), we expect RBI to be aggressive with rate hikes going forward to both cool down inflation and protect the rupee.

Higher interest rates on fixed deposits and losses on equity portfolios will again lead to rebalancing and most people will slowly bite the bullet and move back to fixed-income investments.

It’s happened in the past (Morgan Stanley growth fund, 1994) and we have no reason to believe that there is a secular change in the behaviour of the retail investor.

Further, we expect the Indian markets to be sideways to negative for the year. There will be certain pockets of the economy that will do well but also segments where the valuations still have a long way to correct.

However, retail investors who lose large chunks of their wealth will re-evaluate their risk profiles.

Only time will tell — whether the Indian retail investor has matured or were the recent flows into the stock markets a result of lack of returns in the fixed deposits and FOMO driven by their neighbours making money!

At our end the sectors that we are wary of are –

• Consumption – It is feeling the input price pressure heat, their near all-time high valuations notwithstanding.

• IT — where their employee costs have gone through the roof along with “back to office” being the clarion call, costs are moving up sharply.

• Banking – Where I believe it will have its own set of challenges – we have just been selling “retail loans” for the past 10 years – this is the first serious Inflationary bout that households will see – we may have delinquency challenges at the margin which can make banks tighten credit – which can impact fresh disbursements.

Unfortunately, a lot of these sectors are heavily represented on the benchmarks and thus will cause pain to retail investors.

We do believe that there are pockets within the markets where investors can make money, but these are sectors that are significantly under-represented in the benchmark –

• Short Cycle Capex – Indian corporates are expanding capacities.

• Commodities – Globally we have under-invested in commoditised which is now coming back to bite us. Given the significantly long gestation periods, we believe this cycle will be a 5-7 years cycle before it peaks out.

• B2B Manufacturing – China factor and moving away from “just in time” to “just in case” inventory will go a long way in creating a robust Indian manufacturing. Even a 3 per cent dip in Chinese market share in these sectors can potentially see Indian companies growing by 25-30 per cent.

• Auto and pharma – We see a lot of value emanating out of these two sectors in the times to come.

In line with the above thesis, we have positioned our portfolio.

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