It's SANJU vs HRITHIK in the Stock Market. Which Side Are You On?

The Indian stock markets have become quite dramatic these days. It's resembling a Bollywood movie.

I wrote to you about this - Is 'Sanju baba' behind the crash in small-cap stocks?

You see dear reader, there has been no rationality and moderation in Sanju baba's life.

His life story is full of turbulence, high emotions, and extreme ups and downs. He didn't do anything in half measures. Doing drugs, dating women, buying deadly weapons... he did everything in extremes.

Aren't small-cap stocks just like that?

When they're in a bull run, they defy gravity and soar like they are on drugs. And when they fall, they fall like a stone. Just the way a drug addict plunges into a mental abyss once the effect of the drug wears off.

Many a small-cap stocks have gotten into trouble like Sanju baba and fallen sharply over the last few months.

Mere Paas HRITHIK Hai...

Then there is the other extreme. There's a small group of stocks that's defying gravity right now. They are driving the Sensex to new life-time highs - HRITHIK stocks.

HRITHIK stands for...

H: HDFC BANK and HDFC

R: Reliance Industries

I: Infosys

T: TCS

H: HUL

I: IndusInd Bank

K: Kotak Mahindra Bank

Last month, I wrote to you about how the Sensex is a skewed and biased market barometer (Read: The 30% Stock Market Crash Is Almost Here...).

More recently, I'd penned a premium note for my Insider readers revealing the inside story of Sensex 36,548.

In this note, I showed them how just a handful of heavyweight Sensex stocks have been taking the benchmark index higher. And even within the Sensex, there are quite a few stocks that are still falling.

My friend and technical analyst Apurva Sheth recently penned an entertaining note on HRITHIK stocks.

He pointed out some compelling statistics...

• Over the last one year the total market capitalisation of all the stocks listed on the BSE increased by approximately 22 trillion rupees. Of this, nearly 9 trillion (41%) came only from these eight HRITHIK stocks in the index. A major portion of the wealth in the Indian stock markets was created only from these eight stocks over the last one year.

SANJU vs HRITHIK: What's Your Pick?

So, there are two extreme scenarios playing out in the Indian stock markets right now. There are small-cap Sanjus that are going through a painful correction. And investors are dumping them left, right, and center.

On the other hand, there are gravity-defying HRITHIK stocks lifting the Sensex to newer highs. There's a lot of money pouring into large-cap stocks while abandoning small and mid-cap stocks.

Last week, the government informed the parliament that the Employees' Provident Fund Organisation (EPFO) had invested Rs 48,946 crore in exchange traded funds (ETF) till 30 June 2018.

Here's the interesting detail...

The retirement fund body is investing in ETFs based on Nifty 50, Sensex, Central Public Sector Enterprises (CPSE), and Bharat 22 indices.

It does not invest in shares of individual companies.

This means that all its investments have poured into ETFs of large-cap stocks in the leading indices. The EPFO is not investing any money into small-cap stocks.

The important takeaway here is that a lot of institutional money is predominantly going to pour into large-cap stocks.

Now, here's my question to you...

Which side are you on? What, according to you, are the best potential investments in the market right now - SANJU or HRITHIK stocks?

I've been thinking about this question myself. Here's my answer...

I'm Superstar Agnostic

The markets are clearly choosing HRITHIK over SANJU right now. But I don't see any point in taking sides.

I'm agnostic to market capitalization. I will pick stocks wherever I find value and opportunity.

For instance, at my premium newsletter Insider, I have two open positions from the HRITHIK stocks. And one of them is still actionable. (But given how close it is to the recommended maximum buy price, I'm not sure how long this opportunity will last.)

Not All Small-Cap Stocks are Duds

While small-caps ruled the roost in 2017, the sentiment has completely changed and investors have been dumping them.

I completely understand that it is very painful to see your stocks nosedive.

But if you look at the big picture, this is a healthy cleansing process that's underway in the small-cap space.

Last year, a lot of dud small-cap stocks had sky-rocketed due to a flood of speculative money. Now, that liquidity tap has dried up. And small-cap valuations are slowly coming back to reality.

The important thing to remember is that Not All Small-Cap Stocks are Duds.

Even within the risky small-cap space, there are fantastic businesses run by visionary promoters. So, the ongoing small-cap correction is, in fact, a boon in disguise. It may offer good entry points into bluechip-like small-cap businesses.

In fact, one such small-cap stock that was under my radar came within its buying range just last week. And I quickly recommended it to my Insider members.

You see, as editor of Equitymaster Insider, I have access to almost all the research from Equitymaster's various recommendation services. So, whenever I find a great investment or trading opportunity, I'm at full liberty to reveal it to my readers.

You can join me as an Insider here...

Chart of the Day

Last time, I showed you how small-cap stocks have been going through a painful correction, even as the Sensex scales new highs.

Does this mean it's better to invest in Sensex bluechips and avoid the highly volatile small-cap space altogether?

The ongoing market action seems to validate this concern.

Darlings in 2017, small-caps seem like ugly ducklings in 2018.

You see, the recency bias makes the Sensex look like a hero and small-caps look like losers.

Now, before you join the bandwagon and write off small-cap stocks, I'd like to present you a long-term comparison between the BSE Sensex and the BSE Smallcap Index.

Sensex vs Smallcap: 2003 to 2018

Now, when you look at the movement of the Sensex (blue line) and the Smallcap index (red line) over 15 years, it offers some interesting insights:

• Small-cap stocks have a tendency to make extreme moves. In a bull rally, they make very steep ascents. But when the tide changes, they witness the steepest falls.
• Sensex stocks tend to move in a relatively narrower, steadier manner compared to small-caps.
• Over 15-years (23 July 2003 to 23 July 2018), the BSE Smallcap index and the BSE Sensex are up 1,187% and 1,026%, respectively.
• Despite the sharp correction in the Smallcap index in 2018 and the corresponding rise in the Sensex, the Smallcap index is still ahead of the Sensex from a 15-year time horizon.

I hope this offers you a big picture perspective of what's going on in the market.

Do not expect a V-shaped recovery in small-cap stocks.

Given the way things are, there could be more pain in store. So, invest at the right prices and be careful with your allocations.

While I'd suggest you invest with caution, remember that such times of pessimism often offer great entry points for long-term investors. So, the key is to strike a balance between fear and greed, and to make well-thought and planned investing decisions.

Happy investing!

Ankit Shah (Research Analyst)
Editor, Equitymaster Insider

PS: Every day the markets are open, Ankit Shah cherry picks one idea from our 8 premium publications, the one he considers the best moneymaking opportunity. He shares this one idea with an exclusive group of readers on his 'Insider' list. Today, you have the chance to join this exclusive group by clicking here.