The financial media has painted the narrative that the ongoing rally in global markets has been primarily driven by FOMO (Fear of Missing Out) given the overall weakness of economic data. The Nifty has been exceptionally volatile in 2020. The index hit an all-time high of 12,430 on January 20, 2020. Following the spread of Covid-19 and the subsequent lockdowns the index fell (40%) to an intra-day low of 7,511 on March 24, 2020.
I explained in my last article, why there appears to be a disconnect between the stock market and the economy. Although the precipitous fall in the index was clearly a bear market (defined as a stock index dropping 20% from its peak), the subsequent recovery is the beginning of a new bull market. Since the March lows, the index is up 32%. Analysts and investors are incorrectly defining the current rally as FOMO due to the weak economic data.
However, the fund flow data from India doesn’t support that theory. The vast majority of investors are still sitting on cash or cash equivalents and are too scared to invest. Investor sentiment remains negative and bull markets are built on disbelief. In order for investor sentiment to be considered excessively positive, the fund flows would have to reverse. This means I would have to see at least double or triple the amount placed into equity funds relative to liquid funds to come to the conclusion that markets were too frothy.
According to the Association of Mutual Funds in India, investors pumped INR 5,256 cr. into equity funds in May, reflecting a 15% m-o-m decline from April. Superficially this amount looks relatively large especially given the recent performance of the stock market. Given that most investors are prone to panic at any sign of volatility, I would’ve expected outflows in absolute terms.
The table above supports the view that investors are continuing to invest despite the economic and stock market weakness that we’ve seen since March 2020. However, the equity inflows appear absolutely minuscule compared with the flows into Liquid funds.
Investors parked INR 61,870 cr. into Liquid funds in May and INR 68,848 cr in April. Liquid funds are used primarily as a cash alternative. Investors park money in Liquid funds to pick some additional yield before deploying it into a longer-term debt fund or equity fund.
As the lockdowns slowly end across India and the world, the natural question that arises is what will the recovery look like. Will it be a V, U or the dreaded L-shaped recovery? The correct answer is that it depends. By forcing the economy to shut down, a government can essentially create a recession. However, the converse is not true. Simply by opening up the economy, a government can’t manufacture a recovery where rising output leads to job gains which leads to additional spending. But one thing is clear, the stock market as a forward-looking indicator will always bottom before the economy.
While many pundits fear the current rally is overbought, the fund flow data confirms that investors remain scared. Until we have a shift in attitude among investors from fear of losses to fear of missing out, we will remain in the early stages of this nascent bull market. My personal opinion is that we won’t have a re-test of the March lows as long as we don’t get a 2nd wave of Coronavirus cases. I still prefer to make investments base on individual companies, but I don’t think there is significant downside risk in the overall index from current levels.