Kotak Institutional Equities in its latest strategy note said non-institutional investors may want to attribute the recent high stock market returns to their investment skills, but it would prefer associate part of the rally with luck also. The brokerage said the domestic stocks have been at inflated levels for a while, which increases the odds of a correction. The driver of a correction could be anything, but the outcome will be the same, it warned.
Giving counterfactual examples, it noted the government has no compulsion not to sell stakes in PSUs and said stratospheric valuations of certain PSUs may not hold up with large government stake sales. The setback in Vodafone Idea is a case of ‘luck’ going the other way, it said while citing the recent AGR setback for the telecom operator.
The brokearge said institutional investors have focused on potential sources of risk but oddly ignored the fact that the biggest source of risk could simply be the large gap between current prices and fair values of stocks across the board.
"Greed of returns has overwhelmed fear of risks (visible or invisible). The fact that the investors have made high returns will mean little in the event of an eventual alignment of stock prices with fair values," Kotak Institutional Equities.
The high levels of embedded risk in current high valuations is being ignored by the market, it said, even as investors worry about potential risks that can derail the rally.
Kotak said the large inflows into domestic equity mutual funds from retail investors and into markets from mutual funds show the high levels of greed in the market.
"As we have argued before, high conviction at all price points among retail investors with limited investment experience due to high returns over the past 3-4 years has led to the high levels of confidence (greed) among investors of all kinds," it said.
Kotak said it can only hope that there is a sufficient time gap between now and a correction, which could partly close the gap between the current stock prices and their fair values through roll-forward of earnings.
"The impact for investors will depend on the ownership of the shares at various points in time in the upcycle (and eventual downcycle)—two extreme cases will help appreciate this better. If the share price of a company was to go from Rs 100 to Rs 500 and correct to Rs 200 eventually, the outcome is still a great one for an investor if he or she was to hold the stock through the ride but will be very painful for the investor who would have bought it at Rs 500 (Rs 300 loss) and very joyous for the investor who would have sold it at Rs 500 (Rs 400 gain)," KOtak said.
The large churn in several high-performing but low-quality stocks should give investors enough food for thought about large loss to a certain set of investors at some point in time, it said.