Sensex and Nifty: Market representatives or in a league of their own?

Investors expecting a repeat of the 2014 performance in the stock markets are at their wits' end nowadays. While the major indices are booming, many of the stocks are languishing. The 52 week high - low ratio is only about 5 to 10 %, implying that a majority of the stocks are near their 52 week lows. This is in sharp contrast to 2014 - 15 when the midcaps and smallcaps were leading the charge. While the financial media is filled with stories of booming markets (meaning Sensex and Nifty), the reality many investors are experiencing is a far cry from the 2014 heydays.

 There may be several reasons for the same:

1. After a breathtaking rally, smallcaps and midcaps are pausing for breath.

2. Growing popularity of Index Funds.
Investors are coming to see Index funds as a relatively low-risk option to enter the market. This trend already established in the US will only continue to grow because of the several advantages of an index fund. Namely, the opportunity to have exposure to the broader market with minimal company-specific risks, low fees and comparably decent returns. As can be seen, the Sensex has been the best performing index over longer periods of time including the 2008 crisis.

3. Risk-averse Investors. 
After the IL&FS crisis, investors have turned risk-averse shunning companies loaded with debt such as Zee, DHFL, Jet etc. Although this may also be a time to pick up companies with strong fundamentals whose industry is passing through a bust such as the auto sector.   

Investors need to evaluate their holdings and sectors independently and not get drowned in the market noise. Also, investors long used to treating the major indices such as Sensex and Nifty as representative of the broader market may want to re-examine their assumptions.

Bonus shares: no free lunches?

If there are two b-letter words that get investors all hyped up and frenzied, they are buybacks and bonus shares. 

In the case of buybacks, the investors wrongly imagine that the entire value of their shareholding has risen, even though only a miniscule portion may be eligible for the buyback and the hyped-up price may quickly correct back.

In the case of bonus, there is a perception that you are getting something for free. Even though the reasoning may well argue that there is nothing free; the emotions overrule and logic is swept aside.

Now let us look at bonus shares. Generally, upon issuance of bonus shares the market value reduces and the number of shares rises resulting in more or less the same total market value. Previously, the long term capital gains (LTCG) on shares were exempt. However, the Finance Act 2018 has removed this exemption and taxed the LTCG. Let us see how this will impact bonus shares.  

First we will look at the tax impact if bonus shares were issued prior to 31.01.2018 and next at the tax impact if bonus shares were issued after 31.01.2018. We will also look at the tax impact if no bonus shares were issued.

Prior to 31.01.2018, if you held the bonus shares for more than 1 year, they would be tax-exempt. But after 31.01.2018, the tax treatment has changed. Let us see how.

So as can be seen, bonus shares were not a very tax-efficient method of rewarding shareholders. Prior to 31.01.2018, the investor could atleast wait for a year and then sell his shares tax-free. However, after 31.01.2018, bonus shares have become even less tax friendly. Investors would well keep in mind that there are no free lunches. 

Notes:

1. The above calculation assumes there is no LTCG to set off against the LTCL.

2. LTCG below Rs. 1,00,000 is exempt.

3. Market value in case of no bonus shares is calculated by applying the bonus ratio.