Return difference of Nifty 50 vs Nifty 50 Equal-weight index at all-time high!

The fortunes of the top 10,15 stocks in the Nifty 50 or Nifty 100 has governed the movement of the entire index since Sep 2017. Is this new? The return difference between Nifty 50 and Nifty 50 Equal-Weight Indices is at an all-time high! What can we learn from this? An analysis.

Published: December 21, 2019 at 7:46 am

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The return difference (over two years and above) between Nifty 50 and Nifty 50 Equal-Weight Indices is at an all-time high. The corresponding number for Nifty 100 vs Nifty 100 Equal-Weight is close to its all-time high! We analyse how past return differences correlate with market movements.

To understand what we are discussing, let us consider every possible two-year returns of the NIfty 50 (N50) and Nifty 50 Equal-Weight (N50EW). The dates below correspond to the end date of the 2Y period.

Rolling Returns over two years of Nifty 50 and Nifty 50 Equal Weight Indices
Rolling Returns over two years of Nifty 50 and Nifty 50 Equal-Weight Indices

Over the 3725 returns possible for each index, notice the returns in the white oval. The N50EW returns have never dropped so much below the N50 returns in the past.

This can be seen better by plotting N50EW-N50 (2Y returns), that is the return difference and the Nifty 50 movement.

Two year return difference, that is Nifty 50 Equal Weight Minus Nifty 50 plotted against the Nifty 50 movement
Two-year return difference, that is Nifty 50 Equal-Weight Minus Nifty 50 plotted against the Nifty 50 movement

Notice how sharply the return difference fell after late 2017. The current N50EW-N50 difference is the lowest for all return durations two years and above. This immediately begs the questions if the trend reverses, and it must, sooner than later, will the Nifty fall? Or will the bottom 80-85 stocks of the NIfty move up?

From Feb 2005 to Nov 2007, the longest monotonous fall in N50EW-N50 corresponding to a bull-run (overall), terminated by the 2008 crash. During this period, the midcap and smallcap indices moved up faster than the Nifty.

The current fall in N50EW-N50 from Sep 2017 is fundamentally different as it corresponded to a fall in midcap and smallcap stocks.  It is hard to draw inferences from these but is clear that the current state of the market seems to be quite different from what we have witnessed at least in the recent past.

The corresponding graphs for NIfty 100 and NIfty 100 Equal-Weight indices are shown below.

Rolling Returns over two years of Nifty 100 and Nifty 100 Equal Weight Indices
Rolling Returns over two years of Nifty 100 and Nifty 100 Equal-Weight Indices

Notice that the N100EW has fallen significantly below N100 since Sep 2017. The N100EW-N100 return difference over two years is close to its all-time low just around the 2008 crash. Again it is incorrect to read too much into these graphs.

Two year return difference, that is Nifty 100 Equal Weight Minus Nifty 100 plotted against the Nifty 100 movement
Two-year return difference, that is Nifty 100 Equal-Weight Minus Nifty 100 plotted against the Nifty 100 movement

The fortunes of Nifty Next 50 has also reflected that of Nifty 100 Equal-Weight index.

Rolling Returns over two years of Nifty Next 50 and Nifty 100 Equal Weight Indices
Rolling Returns over two years of Nifty Next 50 and Nifty 100 Equal-Weight Indices

To understand the origin of this return difference, we need to look at individual stock movements. The last two year returns of Nifty 100 stocks is plotted against their weight in the Nifty 100.

Last two year CAGR of Nifty 100 stocks plotted against their weight in Nifty 100
Last two-year CAGR of Nifty 100 stocks plotted against their weight in Nifty 100

The fortunes of NIfty 50 and NIfty 100 are determined by the same top 10-15 stocks. Notice these have done well in the last two years. Many other stocks outside the top-15 have also done well, but their weights are too small to make a difference.

An equal-weight index, unfortunately, will be equally influenced by stocks with the highest return and lowest return. The standard deviation or a measure of fluctuating daily prices is shown below.

standard deviation of daily returns over the last two years vs weight in Nifty 100 stocks
the standard deviation of daily returns over the last two years vs weight in Nifty 100 stocks

The top 15 stocks of Nifty 100/Nifty 50 have exhibited the least volatility over the last two years.  This behaviour triggered the former Chief Economic Adviser Arvind Subramanian to say “explain to me why as the economy is going down and down and down” while addressing members of the Indian Institute of Management Ahmedabad

The reasons for this is hard to speculate and harder to find universal acceptance. However, a disparity among the movement of NIfty 100 stocks is not new. In fact, a uniform movement of all index stocks may not be good news too.

Between Aug 2011 to Sep 2017, N50EW-N50 2Y return difference was hovering around 0% with some sharp dips and a spike. This period saw some spectacular up and downward movements. The Feb 2016 fall caused panic among members of Facebook Group Asan Ideas for Wealth.

It seems extraordinary that the number of new market participants sky-rocketed after the early 2016 fall especially from tier 2 and 3 cities. Things are changing so much so fast that the Nifty pre-2008 crash is not the NIfty that we see today. A study of NIfty PE reveals how the long-term average has changed over the last few years. See: Is the market overvalued?

Given the disparity in the movements of large cap and mid, small cap stocks over the last couple of years, we can only intuitively expect the N50EW-N50 return-difference to change direction. No one can say when and how. All we can do is, take a moment to appreciate the fact that we seem to be in uncharted waters.

We had pointed out in the Mirae Asset Large Cap Fund Review that the N50EW-N50 return difference can be used to find out if active large cap fund managers can still beat the market. Investors in active large cap funds can track this return difference to check if there is a positive change in the fortunes of their funds when the trend changes.

This begs the question if active fund managers are finding the going tough only because the market is dominated by just a few stocks. While we will consider that in a separate study, the absence of alpha has been reported years ago: This will change the way you invest: S&P Index Versus Active Funds report

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