Market breadth turns sharply positive on hopes of revival in economy

Advance-decline ratio for May best 12 months; Momentum continues in June

The market breadth has turned sharply positive since May on hopes that a decline in covid-19 infections will lead to a revival in the economy. The advance-decline ratio (ADR) for May was the best since June 2020 at 3.8. So far this month, the ratio has continued to remain above three. In simple words, for every one declining stock there were nearly four advancing stocks in May and three this month.

ADR is a popular market breadth indicator, with a ratio of more than two signalling extremely bullish undercurrent.  In June 2020, ADR stood at 4.3 per cent as aggressive monetary easing by global central banks fuelled an unprecedented rally in the equity market.

In March, the ratio had slipped below 0.7 per cent as a lethal second wave threatened to derail economic revival. Since mid-April, investor appetite for risk assets in India has seen a quick and dramatic improvement underpinned by declining COVID cases and a ramp-up in vaccinations. The corporate earnings for March quarter also helped sentiment.

"The global economic recovery has created a healthy risk appetite across asset classes. As we have seen in the last month, we are recovering from the second wave in India. And that has led to improvement in investing conditions,” said Saurabh Mukherjea, Founder and Chief Investment Officer, Marcellus Investment Managers.

Analysts warn that the consistently high market breadth is a sign that the market has turned complacent

Ambareesh Baliga, an independent analyst, said “investors have started ignoring the negative macro indicators once the covid cases started to peak. The markets have been indifferent even to high inflation and spike in oil prices."

An ADR of more than three indicates that the stocks across the board are seeing buying interest. Experts said there could be bubble building in small and micro-caps as many new investors are simply lapping them up without understanding the fundamentals.

Since May, the benchmark Sensex has risen 7.6 per cent, while the Nifty Smallcap 100 index is up 14 per cent and the Nifty Midcap 100 index is up 13 per cent.

"The action shifted to the small and mid-cap. In any bull run initially, we see the large caps moving up followed by mid and small caps and then the action shifts to penny stocks," said Baliga.

Analysts said the market breadth may not sustain at current levels.

"What could cause that fall is more global at the moment," said Andrew Holland, CEO Avendus Capital Alternate Strategies.

On Wednesday, the ADR fell to 0.8 as investors turned cautious ahead of the US Fed policy announcement.

"Because of the liquidity we are seeing this trend sustaining, but finally any rally has to be supported by fundamentals. Compared to the last wave, the second wave of Covid has done much emotional damage, and people fear the third wave. All this will translate into low growth in the next one or two quarters, which markets are not absorbing," said  Baliga.

Holland said a lot of the optimism in markets has to do with the retail side and less institutional.

"It's a broader-based and more retail and high net worth investor driven rally. There will be some small caps that rise for no real reason, and they will come off anyway. One cannot paint everyone with the same brush and simply say all companies are doing great,” said Holland.