Behavioural science, anyone?

Between January 2014 and December 2017, the Nifty has capital gains of 67 per cent (absolute), which works out to about 13.5 per cent compounded. In the past year, the Nifty returned around 28 per cent. Dividends would have boosted returns by another 1.25 per cent per year. 

Several factors have boosted stock market returns since 2014. The inflation rate fell between September 2014 and September 2017 because crude oil prices collapsed from over $100 a barrel to below $40.  High inflows from foreign portfolio investors into debt and equity helped boost the rupee and raised stock prices.  

As the rupee rose, it created a virtuous cycle for foreign portfolio investors (FPIs). India became even more attractive due to capital appreciation on the currency. As more money flowed in, chasing the same universe of stocks, share prices rose again, attracting even more money. A continuation of the bull run will depend on liquidity. Domestic institutions have maintained a positive attitude through this period. FPIs have also been net equity investors since 2014 but with wide variations in annual commitment.   

In 2017, FPIs committed Rs 50,000 crore to equity and bought debt of Rs 1.4 lakh crore. FPIs were net debt sellers in 2016. Their heaviest equity commitment in this period was Rs 97,000 crore (January-December 2014). Their lowest commitment was Rs 18,000 crore in both 2015 and 2016. 

In my opinion, the game-changer has been the retail attitude to mutual funds. The ‘Mutual Funds Sahi Hai’ tagline has really worked. Retail fund ownership has increased sharply. Equity assets under management moved to above Rs 8 lakh crore (November 2017) from around Rs 5 lakh crore (January 2017). 

The net inflow to equity funds this fiscal (April-November 2017) is Rs 1.45 lakh crore. The net inflow for the whole of 2016-17 (April 2016-March 2017) was around Rs 95,000 crore. About 800,000-900,000 new systematic investment plans (SIPs) are being taken every month. 

This indicates the increasing bullishness of retail investors, who also tend to hold direct equity. The two flows go in similar directions. Direct investors buy more equity when they’re buying funds and redeem funds when they’re selling equity. 

‘This time it’s different’ is a dangerous thing to say about markets but the manner of retail investment has indeed, been different. In previous bull markets, retail has generally participated directly.  This time probably half of the retail inflows have come via funds. The SIP usage also means that some money is locked in since people tend to let SIPs run for six months to a year. 

In most bull runs, institutions enter early and retail enters in the latter stages. Then institutions sell at near the peak, leaving retail to book losses. A breakdown in retail sentiment comes later after the market has fallen.

But, in this run, given the volume of fund inflows, retail sentiment would be critical to maintaining the uptrend, or triggering trend reversals. If FPIs and domestic institutions sell, the funds will have enough resources to shore up prices. But, if the funds face serious redemption pressure, domestic institutions won't be able to shore up the market. The FPIs could, but they have other markets to look at since the European Union, Japan and the US are all booming, along with Korea, Poland, etc. So they may, or may not, try to prop up India. 

Retail sentiment should not breakdown for fundamental reasons. Think about it — India's banking sector is busted, telecom is struggling, IT is struggling, pharma is struggling, fast-moving consumer good (FMCG) is flat. Yet, many companies in these sectors are trading at record high valuations. But, retail sentiment can breakdown for reasons which have little to do with fundamentals. Apart from Black Swan events like terrorist attacks, war, etc., there could be strong linkages to political narratives. The market crashed for one brief hour when it looked like the BJP was about to lose Gujarat. That sort of sudden shift in sentiment is hard to anticipate and the political narrative is confused enough to trigger such mood shifts every so often. 

Understanding how retail investors think, or feel, is likely to be very important through the next phase of the bull run. That takes us into realms of behavioural science. This is new territory for everyone.