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Fight, flee or join a stampede?

The unexpected market reaction (sanguine) to an unexpected result in the 2024 national elections (BJP falling short of majority) highlights the unusual nature of the Indian market. Non-institutional investors remain extremely confident about making high returns from the Indian market, irrespective of prices and valuations. Institutional investors can choose to fight, flee or join. 

Shrug off the shock

The market’s sanguine reaction to the shock outcome of the 2024 general elections demonstrates the unusual nature of the Indian market. The market has held up unusually well, despite a ‘bad’ election outcome versus pre-election expectations. New narratives (consumption) have emerged, while old ones (investment) have strengthened. Most parts of the market (large-cap., mid-cap., small-cap.) and sectors are back to pre-election levels, while several more sectors and stocks have scaled new highs (see Exhibits 1-3).

Unshaken faith in high market returns of domestic non-institutional investors

The sanguine reaction of domestic non-institutional investors reflects their unshaken faith about high returns from the equity market. Their high return expectation reflects confidence about high returns in the future too, which has been cemented by strong returns across caps, sectors and stocks over the past 1-3 years (see Exhibit 4). We would note that continued large inflows into the market from non-retail investors simply reflect their expectations of high expected returns from the market, which are based on past returns (see Exhibits 5-8). FPIs have been quiet for a while from a flow perspective (see Exhibit 9).

When fundamentals, valuations hardly matter

In our view, the extreme euphoria among non-institutional investors has resulted in (1) steep increase in stock prices of mid-cap. and small-cap. stocks over the past 15 months (see Exhibits 10-11), including several relatively low-quality and unknown stocks and (2) distended valuations across sectors (see Exhibits 12-17). In this context, narratives have taken firm root, while numbers and valuations have withered—there is very little debate about (1) unrealistic assumptions on profitability and volumes being priced in valuations of stocks and (2) incorrect valuation methodologies being used to justify narratives.

Hobson’s choices for investors

Fundamental investors may continue to struggle with the poor options ahead of them—(1) stay invested or invest in a market, with increasingly tenuous links to fundamentals or (2) exit the market in the hope of a more rational market, if and when it emerges. It is difficult to fight, gauge or preempt the ‘mob’ mentality prevalent in the market. However, arguments of domestic institutional investors about investment compulsions seem convenient—(1) limited opportunity for domestic investors to invest in; money does not move across asset classes or stocks (excluding foreign flows) or (2) better tax-adjusted returns in equities versus other asset classes; this does not hold at all price points, obviously.

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