We know bull markets are marked by broad-based upmove and bear markets see narrowing of the market to a handful of bluechip stocks. The image below highlights exactly this with weight of top 10 Nifty in Nifty 50 index.
In the past whenever the weight of top 10 stocks in Nifty has come close to 60 the broader market has outperformed the top 10 stocks or there has been depolarisation of the market. There is no set rule for when we depolarisation starts. The polarisation happened in past few years because profit growth was polarized. Now that the profit growth itself is getting broad-base I feel markets will depolarise over next 1-2 yrs. What gives me a lot more comfort is that the past returns and valuations of the other 35 stocks remains very attractive. That’s why I am suggesting to look beyond the 10-15 quality names that have done well in past 3 yrs.
Another way this depolarisation usually plays out is when Smallcap index start to outperform Nifty. As we can see whenever Nifty to Smallcap index ratio has been above 1 it’s been good time to shift to largecaps and whenever this ratio has been below 2 it’s been good time to invest in smallcaps. Currently the ratio stands at 1.96. Simply put smallcaps will generate 2x returns of what Nifty will generate over the next few years.
Historically past winning sectors become laggards and past laggards become new winners in the new bull market. Whether this time it is different is something I don’t know. When this table with turn, I don’t know and I have no ability to predict that. But it’s good to have this perspective that there is a good amount of rotation that happens in top performing sectors and those sector with very poor past returns can make a very strong comeback while those that have done very well can under perform significantly.
There was a study done by MotilalOswal PW to check how the best performing mutual funds based on past 3 yr returns fared in the subsequent 3 yrs.
According to the study the No. 1 performing fund in 2009-2011 became 167th fund in 2012-14 period, the no. 2 performing MF became no. 40, so on and so forth. We can see that usually the best performing mutual funds of past 3 yrs starts to under perform in the next 3 yrs.
