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Business News/ Opinion / The return of risk appetite in markets
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The return of risk appetite in markets

The Indian stock market may be underplaying the risks of the policy meetings of the US Fed and the Bank of Japan

The turnover concentration for May was the lowest in four months at 58.55% indicating more trading outside the top 100 stocks. Photo: PTI Premium
The turnover concentration for May was the lowest in four months at 58.55% indicating more trading outside the top 100 stocks. Photo: PTI

Britain is set to decide on whether it will continue in the European Union, and two of the world’s most powerful central banks—the US Federal Reserve and the Bank of Japan—will take a call on their policy in mid-June. Both events will happen over the next 10 days. But the Indian stock market may be underplaying both risks. The Sensex has risen nearly 15% from its February lows even though it has pulled back from the high of 27,000 it breached last week.

That risk appetite remains high is evident from the declining India VIX, or volatility index. An analysis of turnover concentration—defined here as the share of top 100 companies in overall market turnover—also shows that investors in Indian markets are none too concerned about these global events. Turnover concentration tends to decrease during periods of market gain and conversely increases when risk appetite reduces.

The turnover concentration for May was the lowest in four months at 58.55% indicating more trading outside the top 100 stocks. This is part of a broader trend as well. Indeed, the last two financial years (FY15 and FY16) occupy two out of the top three spots in terms of years with the least concentrated trading in the last decade. This coincides with the rise in markets around the time the Narendra Modi government came to power.

The decrease in turnover concentration when markets rise is because of higher risk appetite which results in trading in lesser known stocks. This liquidity shifts away from these lesser known names during times of a market decline. This means that investors who bought into such scrips suddenly find themselves with limited opportunity for an exit.

Professor S.S.S. Kumar from the Indian Institute of Management, Kozhikode, compares this to people trying to exit a room through a narrow doorway. The more people try to force their way through the door, the tougher it is to get out, which in turn causes people to try harder. Everyone wants to sell smaller companies and shift to blue-chips during periods of market decline. This means that liquidity migrates to large-cap stocks.

“We get into a vicious cycle," he said.

Investors may want to keep this in mind, especially in the context of the risk posed by unexpected shocks such as a Brexit or global central bank action when straying into lesser known stocks.

Market concentration moves inverse to market gains. Its movement is similar to that of the volatility index which indicates future expected volatility as can be seen in the chart alongside. VIX can tell you how much volatility you can expect in the blue-chip Nifty stocks. Turnover concentration can tell you how easy or difficult it will be to exit the smaller scrips.

Investors should also be wary since the gains in markets over the past two months have been largely driven by liquidity. Fundamentally, not much has changed for the corporate sector and a sustainable recovery in earnings is some time away.

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Published: 14 Jun 2016, 11:30 AM IST
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