Sensex High Hides a Sad Story

On Friday, the BSE Sensex closed at 20,400 points. No, that's not a mistake. I'm sure you've read everywhere that the Sensex closed at an all time high of 21,919.79 points but I don't think that's true.

You see, when one is talking of a comparison between two values, then surely one must compare like with like. And the BSE Sensex of today is not that of 8th January, 2008, which was the earlier significant high. However, the Sensex has seen large changes since that time. Nine of the thirty companies have been replaced. It's literally not the same Sensex any more. If one were to recalculate what the January 2008 Sensex would have been today, then the answer is 20,400. This is not perfectly accurate because one of the nine companies--Satyam Computer--doesn't exist anymore. This alternate value is about six per cent lower than the current Sensex.

You may question this exercise because indices are always changing and if one were to stick to the same set then hardly any comparison would ever be possible. That's certainly true and one shouldn't labour the point too much. However, there's another similar exercise that would make savers and investors understand something important that has happened in the equity markets. This is the massive deviation between the largest companies (represented in the Sensex and the NIfty) from mid-cap and small-cap companies.

The BSE Sensex and the NSE Nifty get all the headline attention and since these two indices have regained and crossed all earlier landmarks. However, down the capitalisation range, the situation is very different. It's never easy to get a visceral sense of the difference between indices at different levels. Therefore, let's artificially equalise two other indices to 20,873 points, which was the level that the Sensex closed at on 8th January 2008. These two indices are the BSE Midcap and the BSE Smallcap.

The contrast between the Sensex and these two is most interesting. First, during the worst phase of the global financial crisis, the Sensex declined to a low of 8,427 points on 3rd March 2009. However, on that day, our Sensex-relative Midcap index was 5,650 points and the Smallcap index was 4,648 points--a far more dire situation. When the Sensex recovered to a high of 21,000 on 5th November, 2010, the Midcap index recovered only to 18,453 and the Smallcap to 17,056 points.

Despite some flashes of good news, this lag of the smaller companies continues unabated. Today, as the Sensex is close to 22,000 points, the smaller indices are nowhere in sight. The Sensex-relative Midcap index has slipped to 14,263 points and the Smallcap one to 10,233 points. These numbers tell us that the 217 constituents of the Midcap index and the 439 of the Smallcap one are nowhere near feeling the great recovery in stock prices that the headlines talk about. That's one major reason that the celebrations over the 'all time high' are so muted.

So what's the moral of the story? Is the smaller company story over? I don't think it's time for such pessimism. At a broad level, in real terms, stock prices have declined a lot. Either on an inflation adjusted basis, or in dollar terms, or in proportion to the nominal GDP stocks all stocks--even large caps--have declined sharply since 2008. At a more micro level, smaller companies have struggled invisibly in the sharply deteriorating but the worst may be over for them.

However, one fact remains. Smaller Indian stocks need the domestic Indian equity investor. It's hard to see the FIIs' single-minded focus on large-cap stocks getting tempered. It's hard to speculate on when the domestic investor will return. The obvious thing to say that it all depends on the elections, but that's a little too obvious now.