Sensex, Nifty falling: Will retail euphoria sustain?

Sensex, Nifty, stock market: Kotak Institutional Equities believes that continued retail euphoria could support the stock market despite high valuations. In a strategy note, Kotak said the stock market may hold up or even go up as long as non-institutional investors stay convinced about making high returns in the market based on past returns and  trailing returns stay reasonably high. 

The latter is obviously valid up to a point only, Kotak said adding that a period of low trailing returns could dampen return expectations among retail investors.

"In our view, a large section of non-institutional investors has become price-agnostic bidders/buyers, as can be seen from
the continuous investment through SIPs into domestic equity mutual funds irrespective of market levels and the large investment in flavor-of-the-month funds such as mid-cap funds, small-cap. funds, sectoral/thematic funds," Kotak said.

This is irrespective of the prices and valuations of the stocks in those sectors, Kotak said.

Kotak feels this has ‘forced’ even institutional investors of domestic equity mutual funds to invest in the market, irrespective of their view on valuations.

"Non-institutional investors have had a very optimistic view of the market and they broadly remain bullish, based on flows into domestic MFs. Their view largely stems from strong returns over their limited investment horizon. We note that a large section of non-institutional investors in the market has pretty limited investment experience," Kotak said.

The Indian market and its components, in particular midcap and smallcap. stocks, have delivered very strong returns over all time periods in the past 3-4 years, except for the past three months. Kotak believes that this lengthy period of high returns has probably led investors to erroneously conclude that they will make money at all price points in the market and they will make astronomically returns in the midcap and smallcap stocks at all price points.

Kotak said institutional investors may be finally recognising the large disconnect between the stock prices and the fair intrinsic values of companies and non-institutional investors may be reviewing their hitherto price-agnostic investment approach. 

"However, the investment sentiment is still very strong among non-institutional investors. A period of low trailing returns
could dampen return expectations (and inflows into domestic mutual funds) among non-institutional investors, the foundation of the rich-to-frothy valuations in most parts of the market," it said.

The domestic brokerage said several low-quality and narrative stocks trade at unfathomable valuations even after the recent sharp correction and will likely see further (severe) correction as and when fundamentals were to prevail fully over sentiment.

Market outlook

Amar Ambani of YES Securities said the Nifty may eventually bottom between 22,200 to 23,000 on a closing basis. Value buying from domestic investors will emerge, followed by FII inflows, he said.

"Investors should exercise caution at this stage and wait for clarity on the direction of the market. With the dollar index strong at 106.6 and the 10-year US  bond yield at 4.44 per cent, there is no room for a quick reversal of FII flows. Investors can focus on areas of strength like digital companies and high quality banking stocks. Largecaps like RIL and Eicher are showing resilience," VK Vijaykumar of Geojit Financial Services said.