The current market conditions have seen the benchmark indices rise to new lifetime levels. In such a scenario many are finding small caps and battered mid caps to be really attractive investment opportunities. It may however be noted that investing in midcaps and small caps may not be that good an idea.
It is important to understand that most of the funds flowing into midcaps and small caps (SMIDs) over the past 2 years have been more from local mutual funds than influx of funds from foreign investors. Now, the best part of the influx of fund into small-caps and midcaps is a thing of the past. This cash inflow, which was one of the major drivers of the rally in smallcaps and midcaps, may have run out of gas.
The pace of purchase of mutual funds has slowed considerably and small caps and midcaps have not performed up to expectations in 2018 in the Nifty. This outcome in the two markets, i.e., the mutual funds (MF) market and the Nifty stock market, has hurt the sentiments of investors.
Investors are looking at oil prices
Surveys have shown that two of the top 5 concerns of investors were elections and the rupee, but their main worry remained the price of crude oil. It is important to know that crude oil price is the main variable that would sway the perception of investors on the levels of Nifty50.
An increase of 10 percent in the prices of crude oil will most likely not change the earnings of Nifty, while depreciation of the India rupee can positively affect earnings. Also, a hike of 10 percent in the average prices of crude oil will result in a rise in CPI inflation by about 25 basis points and result in an impact of 30 bps on India’s GDP growth, if the cost of fuel is transferred to consumers.
It is important to note that every increase of $10 per barrel in the prices of crude oil can hike the fiscal deficit of India by 0.1 percent and the current account deficit by 0.3 percent of the nation’s GDP.
The fall in the Indian Rupee is not a cause of great concern
It may come as a surprise for many, but the truth is that the depreciation in the value of the Indian rupee is not the biggest cause of worry for investors.
At the present moment, a depreciating currency is in reality the last concern for investors in domestic equity. Surveys have shown that currently even the upcoming general election of 2019 is not on the minds of investors.
Over the past decades, a rapid fall in the Indian rupee, when simultaneously occurring with an increase in the prices of crude oil, has resulted in underperformance of the Nifty50 as compared to peers in the emerging markets.
The cocktail of oil and the Indian rupee
Past data has shown that the Nifty50 has usually underperformed as compared to other peer emerging markets during times when there has been an increase of over 10 percent in the prices of oil as well as when there has been a fall of over 5 percent in the value of the Indian rupee.
The price of Brent crude has remained over the mark of $70 per barrel for quite some time. There has been rapid depreciation of the Indian rupee, and it slipped below the level of 70.40 to the US dollar in mid August 2018.
It may however be noted that even though the macro stability of India does get affected by currency and the price of oil, the country is structurally very far away from the fragility situation of 2013.
The impact on overall earnings in reality is just fine. As stated above, an increase of 10 percent in the price of oil will most likely not cause any change in the Nifty earnings.
There is a mixed impact of the rapid fall of the Indian rupee on the market. The depreciation of 5 percent is most likely to increase inflation by 10 to 15 bps, its effect on growth will most probably be positive, when the consequent rise in net exports is taken into account.
The general elections of 2019
During the upcoming period of the next 3 quarters, one of the major factors in Indian markets is the perception of investors about whether or not PM Modi will be victorious in the 2019 general election.
Most reports indicate that investors are of the belief that the PM is set to retain power after the 2019 elections.
It is however important for investors to keep a lookout for different factors such as alliances between opposition parties, due to the complex nature of narrative vis-à-vis arithmetic with regards to the electoral system in India.