BSE 500 Index in deep red : Is it real or deceptive,Is it a buying opportunity. What next now?

As of Friday Feb 2, 2018, the broad-based BSE 500 is down 5% from its 52-Week high of 15,661 which also happens to be its All-time High. That does not sound very bad, but why does it feel much worse than what the Index suggests? If most of us look at our portfolio, a 5% drop from the peak is not reflecting the true picture, Is the Index lying? No, it is all Mathematics. The way an Index is created a higher weight, in general, is given to a company the larger its Market Cap (or free float). In-fact the weight for a particular stock is almost proportional to its Market Cap. So, HDFC Bank has a 6.3% weight and Shoppers Stop has close to 0% weight in the Index. Thus, the Index return is a weighted average return of its constituents. So now we can figure out why we feel much worse than what the Index is saying. We all know that the Large Cap companies have done much better than the mid cap companies in the last few weeks. If for example we took a simple unweighted average of the performance of all BSE 500 stock from their respective peaks, the average is 19%. Although BSE 500 is down only 5%, just 20 out of the 500 stocks are down below 5%. Almost the same number of stocks, 21, are down more than 40%. If one takes stocks down more than 20%, the number is 208, or almost 41% of all the stocks.    The chart below breaks the performance down further:

The above points should make us feel a bit better, although it will not take the returns of our portfolio up! Most of us do not worry so much about Market Capitalisation and Portfolio Weights and we do not have portfolios that mirror the way the Index is made up. So our portfolios do not have the same performance or the risk of the BSE 500 or any other benchmark. If we compare our returns to any benchmark we need to be aware of this. For example, if we have 10 stocks, 5 large caps and 5 mid caps and all equally weighted, our portfolio has 50% weight in Large Cap stocks and 50% in Midcap stocks While BSE 500 may seem like a better benchmark to judge our performance, as all our stocks may be part of that Index, but a better Index is a 50:50 combination of a Large Cap (say BSE Sensex) and a Mid cap (say BSE Midcap) Index. The moral of the story is a that to figure how our portfolio is performing we should compare our portfolio with the appropriate benchmark. Market Optimism Interrupted                       No sooner had It seemed that we are in an optimism phase, The BSE Small Cap Index is down 10.6%, BSE Midcap Index is down 7.9% and the BSE Sensex is down 2.7% over this week. Although Global markets have been jittery since the beginning of the year with US 10-Year interest rates moving up, and the stocks which had seen some signs of Euphoria coming down sharply closer home, the Budget has played a big role in this sharp fall. This begs a question, Is the government trying to bring the market down? In the period 2010-2013, the Singapore government put in a lot of measures to control the speculation and the rise in the property market as it started impacting the economy according to them. The rising property market made “hot money” move to Singapore and also increased the cost of doing business in Singapore. The government measures were aimed to bring macroeconomic stability. Is the introduction of Long Term Capital Gains in the budget a similar move where the government is trying to limit the allocation of money to the stock market? Hon. Finance Minister's speech seems to hint that for sure. Here's some of what he said as a preamble to introducing the LTCG: “With the reforms introduced by the Government and incentives given so far, the equity market has become buoyant.” “Major part of this gain has accrued to corporates and LLPs.” “This has also created a bias against manufacturing, leading to more business surpluses being invested in financial assets.” (unfortunately, no one can deny this observation) Barring the Tax and possibly their intent, I feel the budget was not as bad as the market reaction suggests. Given the fiscal situation of India, a budget is always a balancing act and the government has to decide where they focus their resources on. This government has been consistent in focusing on the “Supply Side factors” like infrastructure and “Inclusive Growth” and this budget they have done the same. The budget is pro-growth, following 12.3% growth in total spending in FY18, the government has budgeted a growth of 10% for FY19. Focus on infrastructure has continued. Railways, Roads, Defense and Agricultural capex have seen the highest growth. The inclusive part of the budget can be seen from the increase in MSP for crops to 1.5 times production cost to ensure higher realizations for farmers' agricultural produce and also the announcement of National Health Protection Scheme. BSE 500 Index -1 Year Returns BSE 500 Index -5 Year Returns I believe that the long-term fundamentals of the India story are intact. This can be seen in BSE 500 1 year and 5-year returns in the picture above .The Market reaction to the budget is similar to that when PM Modi announced Demonetisation. That too had interrupted the Optimism phase for a while. I believe that when the dust settles down, and I have no clue how long that will take, the market will be back to fundamentals. The interruption can be much longer if the government does not want the markets to go up though! Next Read : The Era of Easy Money is Coming to an End. What Happens Now? Previous Read : Skipper- 3QFY18 Result - Transmission Capex Play- On Right Track