From an Indian perspective, the year thus far has been jolted by several macro themes which I believe are notable headwinds for the economy.
First, a hawkish environment in the western world characterised by monetary tightening is a marked reversal to an elongated period of quantitative easing and declining interest rates. Consequently, a textbook “flight to quality” thesis is at play, in effect driving capital outflow from India and other emerging markets inducing a real contagion risk.
Second, an uptick in crude oil prices through the year (crude oil is up 7%+ year-to-date) has pressured fiscal deficits and could pull the handbrakes on the growth profile of an economy that relies on overseas supply of crude oil for nearly 80% of its demand.
The combined effect of the aforementioned two factors have induced the Third - a swift depreciation in the INR which is down nearly 14%+ year-to-date against the USD.
Fourth, escalating US-Sino trade tensions have certainly taken some shine off the global growth outlook.
A deep-dive on these macro themes and others can be found in this excellent opinion piece by Nikhil Arora: Current State of the Indian Economy: Is it Time to Go Bearish?
However, the domestic stock market headlines numbers illustrate a somewhat different narrative. Nifty 50 and BSE Sensex have seen fairly robust growth year-to-date. Nifty 50 is up around 9% and the BSE Sensex is up around 12%. If one were to look at Nifty 50 through just the macro-lens, one could just as easily have expected the opposite movements in the markets. An equally palatable outcome one might argue.
In that context, one wonders if the strength in domestic headline numbers is indeed a proxy for underlying economic health?
A Look Into The Nifty 50 – “Weights” Matter
Nifty 50 is considered the flagship index on the National Stock Exchange, tracking the behaviour of the largest and most liquid blue chip stocks. Given its diverse constituents, healthy liquidity and general clout, it is often treated as a proxy for overall economic health.
However, due to its float-adjusted market capitalization based indexing method, the bigger and larger constituents can meaningfully sway the entire market. While, this is true for all market capitalization based indexing methods, a detailed look at the index constituents makes for an interesting read through. This is all the more interesting given that there are a plethora of macro catalysts simultaneously at play in the current environment.
From a simplistic perspective, higher the weight of the stock in the Nifty 50 index, more is its directional pull on the index.
An example that demonstrates this fairly well is Reliance Industries Limited (RIL). RIL has close to 10% weight on the Nifty 50 due to its lofty market capitalization. RIL stock is up around 35% year-to-date, a remarkable surge which would make even a high risk-high return type growth investor fairly content with the year-to-date return. However, what one might miss easily is the massive say that RIL and its 35% surge has had in moving the Nifty 50 headline numbers, which are the ones that are usually reported by the mainstream press anyway.
Another example is a yet another heavy ’weight’ - HDFC Bank, also constituting nearly 10% to the Nifty 50 weight and somewhat similar to RIL has also seen its stock climb year-to-date. HDFC is up a robust 10% year-to-date and consequently has significantly contributed to Nifty 50’s upward movement.
Reliance Industries Ltd, HDFC Bank, Housing Development Finance Corporation, Infosys Ltd and ITC Ltd together accounting for nearly 40% of overall weight of the Nifty 50 and are all up meaningfully. In fact, all top ten stocks by weight on Nifty 50 are all up year-to-date.
On traversing down the Nifty 50 constituents, one can quickly decipher that bigger weight stocks have generally seen upward movements year-to-date and in turn helped galvanize the broader Nifty 50. An example from closer to the other end of the spectrum is Hindustan Petroleum Corporation Ltd which is down 40% year-to-date making it the worst performer in the Nifty 50 but has less than 1% weight on the Nifty 50 index. In fact, the top 10 constituents by weight on the Nifty 50 are all in the green year-to-date and collectively have enough pull to dictate Nifty headline numbers.
However, drilling down into the Nifty 50, one can see less than half i.e. 24 (at the time of writing) are in the green while the other 26 are in the red. But the 24 stocks in the red i.e. trending down year-to-date, on account of weight asymmetries have significantly lower impact on the broader index. In that context, while the headline numbers intuitively paints an optically pleasing picture, a deeper-dive into the index portrays a less optimistic picture. One wonders if Nifty 50 with just 50 stocks and such diverse market capitalization ranges is even a fair representation of the overall market.