Calm waters hide simmering risks on D-Street | Economic Times

The Sensex and Nifty inched laboriously to record highs last week in a bits-and-pieces upmove. The absence of big moves by the usual index-influencing bluechip stocks put a lid on gains as foreign fund flows fluctuated, keeping directional Nifty traders confused.A look beneath the surface however shows a different picture. In contrast to the sedate moves in large-caps, which form the Sensex and Nifty, many illiquid smaller and penny stocks are seeing one of the strongest moves in recent years thanks to the strong appetite for higher risks and returns among individual investors. In the previous five trading sessions, 555 stocks on the BSE hit 52-week highs on an average everyday. A similar winning streak in mid- and small-cap stocks was last seen seven years ago. In the first week of June 2014, the number of stocks that had hit 52-week highs daily on average was 650. Over the next four years, the bull run in smaller shares continued.Bulls are tempted to believe mid- and small-cap stocks today are at the same stage as they were in 2014. Then the rally went on till January 2018. With retail investors deprived of better investment avenues pumping money into the market, little-known stocks that have not moved much in the past three years are zooming higher. While stock tips of trading gurus on social media are being lapped up, various small- and micro-cap companies have appointed investor relations agencies. The founder of a micro-cap company told ET that he is getting enquires for a block of equities even after his stock ran up 10 times.For small-cap stock pickers, the comfort lies in the valuations relative to the broader market. While small-cap indices are at record highs, valuations are still below long-term averages. The Nifty Smallcap 100 index is trading at a trailing Price to Earnings (PE) ratio of 55 times against the 10-year average of 62 times and the peak of 360 in January 2018. In comparison, the Nifty is trading at a PE ratio of 29 against the 10-year average of 21. The mid-cap index’s PE is at 37 compared with the 10-year average of 27.In the past, mid-, small- and micro-caps rally the most when investors have been hopeful about the economy’s prospects. This time, the economic setting is rather different with the country limping out of a second Covid wave. While the economy is expected to rebound once restrictions are fully lifted, optimism is tepid amid uncertainty over another bout of Covid-19 infections. The buoyancy in the market suggests investors might be indifferent to risks to the economy. The bigger concern among more informed market participants is the US Federal Reserve’s likely reaction to the accelerating inflation there. The American central bank has been reassuring financial markets that the super-accommodative monetary policy is here for a while and price pressures are transient. But the edgy market hasn’t been convinced.Many market watchers believe that the Fed will have to start reversing part of the gigantic bond-buying programme later this year though it will maintain the zero-interest rate regime until the second half of 2023. Brokerage Jefferies’ strategist Chris Wood said rising oil prices are likely to act as a catalyst for an “escalation of inflation scare” in the coming months.While surging oil prices is bad news for India, a senior fund manager said his bigger worry is not the domestic stock market, including resurgent small caps, but US equities, especially the technology giants that are perceived to be overheated by many on Wall Street.These stocks were the biggest beneficiaries of the fresh liquidity that flooded the global market since the last week of March 2020.Any abrupt reversal in loose monetary policy is feared will hit these stocks the most. Global financial markets including India may not be able to insulate themselves in the event of such a sell-off.For now, calm market waters are masking the underlying risks. The drop in the Volatility Index to 14.10 on Friday is an indicator of the optimism. It is a sign of the falling cost of insurance against a market fall. In the past, frenzyamong individual investors to buy a stock to make quick money has been a reliable indicator of caution. The catch: heightened retail participation could never pinpoint the timing of a market top.