It is important to differentiate between the index level and equity markets
The index of National Stock Exchange (NSE) Nifty 50 may soon be touching 10,000. On Monday, Nifty was within kissing distance of that mark, but weakness in the European market stopped its charge. A few more rupees getting added to index heavy weight stocks like RIL, ITC or Infosys and the Nifty should vault over that mark. The moment that happens, analysis on how much time it took Nifty to move from one level to another and what it’s next level will be, are going to abound in the media. There is nothing wrong in these discussions, but the trouble is that for a large majority of retail investors, such milestones becomes an indication of further bullishness of the equity market, which may or may not be the correct way to interpret the move of Nifty from one level to another.
It is important to differentiate between the index level and equity markets and what is happening in terms of economic growth in different sectors and the economy as a whole. All three are different, governed by different factors at different points of time. At the moment, the turbo-charged equity markets are far removed from actual economic metrics, which are subdued and decelerating for almost a year. Markets are a function of liquidity, events and forward earnings potential of companies that make up for the index, both domestic and global.
Indices, whether it is the Nifty or Sensex are an attempt on the part of stock exchanges to show broader direction in which equity prices are moving; no other interpretation is required. Equally, the companies represented on an index are a mirror image of what corporate India is doing, which in turn reflects on how the broader economy is performing.
In the case of the Nifty, the trouble is that the weightage of benchmark is skewed essentially in favour of three sectors — financial services, energy and information technology. Financial services, which includes banks, both private and public sector and housing finance companies, has a total weightage of 35.03 per cent. Out of this, just two HDFC Bank and HDFC constitute a 16.43 per cent weightage. So, what happens to these two companies is enough to give a rosy picture of economic activity even when it might not be the case. In case of any global economic issue, if selling emerges in these two stocks, it will make the Nifty fall sharply and give an impression that economic activity has dropped sharply, which may not be the case. So, both on the upside and downside, such as high weightage to a few sectors and companies creates an issue which is never taken seriously either by the exchanges or by regulators. Compare this with sectors like construction, which has just a 3.85 per cent weightage in the Nifty. In India, only a few construction companies are listed and even fewer have made it so large that they are included in the Nifty. Their stock price movement never captures what is being done by hundreds of small construction companies across the country, forget the Nifty. How much of work and economic growth that has been generated by increased government spending on infrastructure in the last two years has been captured by the movement of Nifty? Probably very little and that too because some cement stock has been able to find a minor space in the Nifty otherwise even that would’ve been left out. In other words, index is a number, which just comes and goes.