Indian retail investors can’t really save our stock markets

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One such story being told by bulls right now in what looks 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, both directly and indirectly, which has helped curb the relentless selling by Foreign Institutional Investors (FIIs). And that’s something we can be proud of.

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

If these DIIs had not invested large sums of money, the fall in stock market indices would have been greater. The high maturity of the Indian retail investor buying while FIIs sell cushioned the market’s fall, and against this backdrop, retail investors should be optimistic. Or at least that’s what we’re 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 story of retail investors leading to the autonomy of Indian stock markets seems like a coherent story, it is not. If we look at FIIs and DIIs over the past decade, they tend to operate largely in opposite ways. Generally, when FIIs buy, DIIs sell, and vice versa. Take the case of the period between 2011-12 and 2014-15; FIIs purchased shares in each of these years and their total purchase was worth 3.75 trillion. On the other hand, DIIs sold shares in each of those years and their total sale was worth 1.51 trillion.

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

From 2015-16 to 2019-20, as the PE ratio rose from around 20 to over 26, meaning investors were willing to pay more for every rupee in company profits, DIIs bought shares with a value 4.27 trillion. During the same period, FIIs purchased shares worth 73,224 crores. Therefore, FIIs buy stocks when stock valuations are low and DIIs (representing Indian retail investors) buy stocks when valuations are high.

In 2020-21, FII purchased shares worth 2.74 trillion, when the PE ratio of Sensex shares was above 28, at a time when central banks were printing money and indirectly driving up stock prices. The DIIs sold shares worth 1.34 trillion during the year. In 2021-22, when this PE ratio crossed 29.5, FIIs sold shares worth 1.4 trillion, as DIIs bought stocks worth 2.21 trillion.

This means that when stocks get expensive, FIIs either 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 route for FIIs and do the exact opposite of what stock market investing is.

Over the past two years, this phenomenon has increased as interest rates have been very low, Internet bandwidth is available at low rates, encouraging more retail investors to buy and sell stocks, and finally , new-age investment apps backed by venture capital funding have made investing in stocks easier than ever.

A corollary of retail investors empowering Indian stock markets is the belief that FIIs have already sold a lot. Well, it turns out they can keep selling. As of May 31, the total value of shares held by FIIs, or assets under custody, as it is technically called, was 44.12 trillion. By comparison, FIIs sold shares worth 2.06 trillion between October and May, and that’s a small proportion of their overall investment.

Finally, in May, US retail price inflation was 8.6%. In December 1981, when retail price inflation in the United States reached a similar rate of 8.9%, the federal funds rate averaged 12.37%. In May 2022, it averaged just 0.77%.

This means that the US Federal Reserve, the country’s central bank, has only just begun to raise interest rates in order to control the high inflation that is currently prevailing there, and the more interest rates rise in the United States, the more likely we will see FIIs selling Indian stocks.

Therefore, Indian retail investors will have to throw in the towel at some point. Given that, it’s time for them to remember two great American clichés: “You ain’t seen nothing yet” and “Let’s get out of here.” Of course, before that, they have to realize that mixing their politics with investing is always a bad idea.

Vivek Kaul is the author of “Bad Money”.

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