Why Indian retail investors cannot really rescue our stock markets

One such story being told currently by bulls in what is looking more like a bear market, is that India has become self-reliant when it comes to investing in the stock market. Retail investors are buying stocks, directly and indirectly, and that has helped take the bite out of the relentless selling being carried out by foreign institutional investors (FIIs). And this is something for us to be proud about.

At a simplistic level, the data matches the argument. Since October, FIIs have sold stocks worth ₹2.2 trillion, whereas domestic institutional investors (DIIs) have bought stocks worth ₹2.65 trillion. DIIs are institutions like insurance companies, mutual funds, provident funds, banks, etc., which primarily invest money they collect from retail investors in India.

If these DIIs hadn’t invested large sums of money, the fall in stock market indices would have been greater. The great maturity of the Indian retail investor who is buying while FIIs are selling has cushioned the market fall, and given this, retail investors should be optimistic. Or so we are being told.

As Daniel Kahneman, Olivier Sibony and Cass Sunstein write in Noise: A Flaw in Human Judgement: “Our sense of understanding the world depends on our extraordinary ability to construct narratives that explain the events we observe. The search for causes is almost always successful because causes can be drawn from an unlimited reservoir of facts and beliefs about the world."

While the retail investor story leading to self-reliance of Indian stock markets sounds like a coherent story, it is not. If we look at FIIs and DIIs over the last decade, they tend to largely operate in opposite ways. Typically, when FIIs buy, DIIs sell, and vice versa. Take the case of the period between 2011-12 and 2014-15; FIIs bought stocks in each of those years and their total buying was worth ₹3.75 trillion. On the other hand, DIIs sold stocks in each of those years and their total selling was worth ₹1.51 trillion.

That was when the price-to-earnings (PE) ratio of the 30 stocks that constitute the BSE Sensex was in the range of 17-19, meaning investors were willing to pay ₹17-19 as a price for every rupee of company earnings.

From 2015-16 to 2019-20, as the PE ratio went up from around 20 to more than 26, signifying that investors were willing to pay more for every rupee of company earnings, DIIs bought stocks worth ₹4.27 trillion. During the same period, FIIs bought stocks worth ₹73,224 crore. Hence, FIIs buy stocks when stock valuations are low and DIIs (representing Indian retail investors) buy stocks when valuations are high.

In 2020-21, FIIs bought stocks worth ₹2.74 trillion, when the PE ratio of the Sensex stocks was greater than 28, at a time when central banks were printing money and indirectly pushing up stock prices. DIIs sold stocks worth ₹1.34 trillion during the year. In 2021-22, when that PE ratio crossed 29.5, FIIs sold stocks worth ₹1.4 trillion, whereas DIIs bought stocks worth ₹2.21 trillion.

What this means is that when shares get expensive, FIIs sell stocks or don’t invest much in them; but DIIs buy stocks when they are expensive and sell when they are cheap. In that sense, they provide a profitable exit path to FIIs and do exactly the opposite of what stock-market investing is all about.

In the last couple of years, this phenomenon has gotten accentuated because interest rates have been very low, internet bandwidth is available at rock bottom rates, encouraging more retail investors to buy and sell stocks, and finally, new-age investing apps backed by venture capital funding have made investing in stocks easier than it has ever been.

A corollary to retail investors making Indian stock markets self-reliant is the belief that FIIs have sold quite a lot already. Well, as it turns out, they can continue to keep selling. As of 31 May, the total value of stocks owned by FIIs or assets under custody, as it is technically referred to, stood at ₹44.12 trillion. In comparison, FIIs have sold stocks worth ₹2.06 trillion between October and May, and that’s a small proportion of their overall investment.

Finally, in May, retail inflation in the US stood at 8.6%. In December 1981, when American retail inflation was at a similar 8.9%, the Federal funds rate averaged 12.37%. In May 2022, it averaged only 0.77%.

This means that the US Federal Reserve, the country’s central bank, has just about got going when it comes to raising interest rates in order to control the high inflation that currently prevails there, and the higher that interest rates go in the United States, the more we will likely see FIIs sell Indian stocks.

Hence, Indian retail investors will have to throw in the towel at some point of time. Given this, it’s time for them to remember two great American cliches: ‘You ain’t seen nothin’ yet’ and ‘Let’s get out of here.’ Of course, before that, they need to realize that mixing their politics with investing is always a bad idea.

Vivek Kaul is the author of ‘Bad Money’.