The retail risk

Stock market may test retail participation this year

The strong bull run of last year in the stock market was driven and buttressed by retail interest. In calendar 2021, the value of retail equity holdings went up by over 60 per cent, and the number of active dematerialised accounts registered an increase of over 30 million. In addition to direct equity investments, individuals also held exposure through instruments like mutual funds (which also saw record inflows), pension funds and unit-linked insurance plans. While retail interest is welcome as it enables household savings to be deployed as risk capital, it also increases risks for individual investors. This can leave the stock market vulnerable to sudden changes in sentiment.

The rise in market value of retail equity holdings has far outstripped the rise in benchmark indices like the Sensex and Nifty. It’s clear the retail focus is on smaller stocks, and the small-cap and mid-cap indices have outrun large-cap indices, though all indices are trading at, or close to record peaks. There has been a lot of primary market activity, and retail participation in initial public offerings (IPOs) has also been high. In this regard, the increase in dematerialised accounts may be a little misleading. An individual may hold multiple dematerialised accounts. Many opt to do so since each of such accounts may be cited in a separate IPO application, increasing the chances of allotments. The extent of reliance on retail investment can be noted by comparing institutional attitudes. Domestic institutions (including mutual funds and insurance firms, which are dependent on retail inflows) had net equity buys of Rs 94,846 crore in calendar 2021, while foreign portfolio investors (FPIs) had net equity sales of Rs 91,626 crore in the same period. A broad-based rally, which pushed overall market capitalisation up by over 40 per cent, only occurred due to direct and indirect retail interest.
 

This retail rush had multiple drivers. It reflected the absence of alternative investment avenues in 2021. Interest rates were low, not only in India but globally, as central banks opted for easy monetary policies to combat distress. The real estate market activity was also muted. While the unorganised sector suffered, the organised sector did well. Big companies deleveraged their balance sheets and profits increased significantly. Although the retail interest in the market is understandable, sustainability remains to be seen. The market capitalisation-to-gross domestic product ratio is at an unprecedented level of 1.8 times, and India is the most richly valued emerging market. At the current price-earnings valuations, there is no room for disappointing results. Low-base effects from 2020-21 led to elevated returns in 2021-22. But this inevitably means the high-base effect in 2021-22 will translate into more moderate returns in 2022-23. 

The FPIs cut India exposure in calendar 2021. Their advisories indicate they will continue to scale back in 2022, with a hawkish Fed signalling it will hike interest rates and tighten money supply. The Reserve Bank of India is also normalising policy. In this context, it is worth highlighting that a substantial component of retail exposure consists of “hot flows”, with traders seeking quick returns via leveraged positions, alongside high-risk derivatives exposure. This money can exit quickly if the trend turns negative. This in turn can induce higher volatility, since retail investors tend to panic when things aren’t going their way. Ironically, the stock market may see a correction in 2022, even as economic activity recovers.