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No Joke: Nifty to Get Pricier This April Fools' Day

Mar 8, 2016

In this issue:
» Are Retail Investors Exiting Mutual Funds?
» China's Economic Woes Get Worse!
» ...and more!
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Devanshu Sampat, Research analyst

The BSE Sensex and the NSE Nifty...

The benchmark indices of nearly all market participants...

The barometers of the Indian stock markets...

The representatives of India's finest companies...

The Nifty represents about two-thirds of the free-float market cap of all listed players on the National Stock Exchange. The Sensex represents just under half of the Bombay Stock Exchange.

The top three sectors for both indices are financial services, information technology, and energy. These sectors make up about 60% of the Nifty. And if we add the next two largest sectors - consumer goods and automobiles - the weightage of the top five sectors is nearly 80%. It's a similar story for the Sensex.

As per the NSE website, the purpose of Nifty 50 is to...

  • Cover major sectors of the Indian economy and offer investment managers exposure to the Indian market in one efficient portfolio. The Index has been trading since April 1996 and is well suited for benchmarking, index funds and index-based derivatives.
  • The Nifty 50 is a diversified index, accurately reflecting the overall market. The reward-to-risk ratio of Nifty 50 is higher than other leading indices, offering similar returns but at lesser risk.

Every six months, the index is reviewed. The stock exchange gives a four week-notice to the market before making any changes.

Changes from the most recent review include the addition of Eicher Motors, Bharti Infratel, and Aurobindo Pharma (along with Tata Motors' DVRs) to the index beginning April 1, 2016. Cairn India, Punjab National Bank, and Vedanta will be cut.

With these changes, the weight of mining, energy, and banking stocks will decrease. And pharma, auto, and telecom will increase.

A recent Economic Times article highlighted that with this change, high return on equity businesses will now have a higher weightage (of about 50%) in the Nifty:

  • Some experts believe inclusion of high-growth, high-RoE segments will prevent the index from being an accurate barometer of the broader economic health. The lower weight of cyclical stocks means the index will fail to capture the uptick in these stocks when global liquidity starts chasing beaten-down value stocks. Also, the index's ability to capture the stress in certain sectors, such as banking, is diminishing.

These kinds of changes are naturally periodic. A year ago, DLF and JSPL were replaced by Idea Cellular and Yes Bank.

But this time the quality of companies is quite different. High-growth companies with above average earnings will replace companies with volatile earnings patterns.

What to make of this?

Well...one thing is for sure: With high-flying names replacing struggling companies, the index is about to get pricier.

And that's definitely not a good sign!

Will this churn in the index bring about any change in the way forward for the broader markets?

As a research house, we do not have any index targets per se. All we can say is that, for the benchmark indices to move considerably in any direction, a LOT will depend on just a handful of companies and sectors.

As I wrote in the 5-Minute Wrap Up about six months ago:

  • The largest company in the Sensex has a weightage of 12%. The top five companies have a share of 36%. The top 10-60%. And the top 15 (half the index) form as much as 77% of the index!

Within the Nifty, the largest company has a weightage of 9%. The top five companies have a share of 31%. The top 10 - 49%. And the top 25 (half the index) - 80%.

The BSE Sensex and the NSE Nifty play a huge role in determining market attractiveness. And so it would only make sense to focus on the risk-reward ratios of the major contributors.

To get your started on this process...I suggest you give our largecap stock recommendation service StockSelect a try. After all, it has an excellent track record average of 77.3% from 2002 to 2015. This means nearly eight out of every ten stocks recommended through StockSelect have hit their targets!

There are Four Bluechip recommendations on which you could act right away.

Do you determine your equity exposure based on the attractiveness of the NSE-Nifty index? Let us know your comments or share your views in the Equitymaster Club.


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2.45 Chart of the Day

In last Thursday's edition of the 5 Minute WrapUp, Rahul Shah had highlighted how mutual funds are net buyers in the markets. This at a time when FIIs are selling. This is indeed a heartening sign. It can be explained by the fact that many retail investors have wisely opted for the SIP route to invest. The amounts may be small to begin with but it adds up over time.

However, the latest news is not good on this front. Inflows into mutual funds have fallen for the third month in a row. In fact, as per a Mint article, if SIPs are left out of the calculation, funds are being withdrawn from mutual funds. This is bad news we believe. As markets correct, investors should increase their exposure to stocks. Sadly, the reverse seems to be happening. Investors who jump in to mutual funds when markets are rising and exit when markets are falling will not build wealth in the long-term.

A Decline in Equity MF Investments

3:50

Tanushree Banerjee, had stated in last Friday's edition of the 5 Minute WrapUp, that China's manufacturing sector is in for tough times. So the news that China reported disastrous trade data for the month of February, did not surprise us. China's exports crashed the most in six years. The 25.4% plunge was far worse than anyone's expectations. Imports fell for the sixteenth month in a row, down by 13.8%.

It makes us wonder if the Chinese government's new five-year plan is a work of fiction. The GDP growth target for the next five years is an ambitious 6.5%. Even this will be the slowest growth in the last 25 years. However, no one takes China's economic data at face value anymore. We don't believe that China will grow at 6.5% either this year or the next five. The ground reality just does not support such high numbers.

4.45

After opening on a flattish note, the Indian Markets witnessed choppy trading. At the time of writing BSE Sensex was trading higher by about 12 points. The BSE Mid Cap index is trading higher by 0.2% while the BSE Small Cap index is trading up by 0.6%. Sectoral indices are trading mixed with stocks from the metal and energy stocks leading the gainers.

4:50 Today's Investing Mantra

"It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Devanshu Sampat (Research Analyst).

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Equitymaster requests your view! Post a comment on "No Joke: Nifty to Get Pricier This April Fools' Day". Click here!

1 Responses to "No Joke: Nifty to Get Pricier This April Fools' Day"

r.murugan

Mar 8, 2016

ITS MY VIEW ONLY INDIAN ECONOMICS TO BECOME WORST IN FORCOMING MONTHS.ALL INVESTER TO EXIT MARCH AN APRIL 2016.ALL BANKING SECTOR GET POOR RESULT IN MARCH YEAR ENDING.

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Equitymaster requests your view! Post a comment on "No Joke: Nifty to Get Pricier This April Fools' Day". Click here!
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