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What does the recent broad-market rally in markets tell us?

A key characteristic of the rally in Indian stock markets since April 1, 2020 is its broad-based nature. Contrary to the polarization seen in CY2018 and CY2019 when a few high quality names kept the bellwether Nifty 50 up, the recent rally has witnessed broader participation of mid-and-small cap stocks. This broad nature of the rally has clearly provided opportunity to investors to make money. But this does not mean that everyone invested made handsome money.

The quantum of money you earn in markets is directly linked to stocks you buy.

The rise and fall in each stock is not the same—some stocks rise more than the index while others underperform it. And a key thing that drives these movements is sentiment. As sentiment keeps changing, investors need to align their portfolios by including winners in their portfolios.

A look at bullish phase of markets in the past makes it clear that selection of right stocks can help you outperform the markets. Out of the seven bull markets seen post April 1, 2003, 33% to 66% stocks outperformed the benchmark—the Nifty 500—a barometer for the broad market in India. Only 33.3% stocks outperformed the benchmark in a bull market between August 1, 2006 and December 31, 2007. On the higher side 66% stocks outperformed the benchmark in the upward movement between March 1, 2009 and October 30, 2010.

Investors looking for excess returns over the index have to buy stocks that outperform the benchmark by a wide margin. For example, in the recent bull-run between April 1, 2020 to December 31, 2020, 45% stocks outperformed the Nifty 500 – but the highest outperformer stock gave returns of 574% and the least outperformer stock gave return of 22.65%. Each time an investor cannot spot the biggest gainers in a bull run. But it is pertinent to buy some winners and hold on to them till bull-run lasts. Weeding out non-starters or stocks that go down in a bull market is also important.

To achieve these objectives, investors need to understand fundamentals of the business of a company and the price action reflected in the company’s share price. They have to constantly monitor stocks in their portfolio and ensure that their portfolios consist of companies which appear in the list of companies which fall in top-quartile of the returns’ chart.  

Today, thematic and sector-focused funds are being launched. It is instructive to look at past returns of these categories of funds. Narrowly-defined thematic funds limit the universe of stocks for a fund manager. If stocks associated with a theme do not participate in a rally, then an investor’s portfolio faces the risk of underperformance with respect to the benchmark. Only when investors understand the demand situation in a sector and themes emerging from that sector can she select stocks which will provide handsome returns. This demands full attention and intricate understanding of nuances which drive or destroy revenues of a company. Not all investors are capable of doing this. Some lack skills. Some do not have required time. There is a section of investors which lack the inclination. Hence, it is vitally important that investors seek expert advice before investing in such themes.

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