This is a repost. Those who read this at investnow.lk , need not to read. Nothing much new hence. However I think it is relevant here.
Except at the base year of ASI and Sensitive price index (predecessor of MPI) MPI stood above the ASI in the history (as daily close of 1985-2007). From January 02 , 1985 to 20 March, 1985 Sensitive price index outperformed ASI , however, not more than 15 units.
As shown in the graph ,in general, when MPI goes up/down ASI increase /decrease at a lower rate resulting higher gap when MPI increases and lower gap when MPI decreases (alternatively one can say up markets and down markets).
However, the gap had an increasing trend (see the graph). My explanation on this trend is that investors favored big companies in the past. Why?
It is well known that Sri Lankan political, economical and security situation was heading at what direction. In an uncertain environment, it is reasonable to expect big companies have resilience to face such volatilities. Therefore investors chose big companies (and most of them are highly traded, so less liquidity risk too) to put their money in.
But improved macro economic conditions were able to decrease expected risk in the CSE. The decreased expected risk persuaded investors to invest in small and medium cap stocks with less hesitation (with the confidence that economy will boom, hence the CSE also (one may call this as price speculation!)).
Then I should answer the question “why investors favored small and medium caps”. It is a well known theory that small caps have higher return compared to large caps, call the size effect (the size effect in the USA and many other develop countries have disappeared after publishing the size effect, but in Sri Lanka size effect was still in effect see Samarakoon, (1997) , and Nanayakkara (2008) for example (I’m non of them!)). It is said that the reason for higher return on small caps is a reward for bearing risk (as small caps are relatively risky compared to big companies in facing challenges).
With this shift in investment pattern, the small and medium caps also started moving together with large caps making the gap between ASI and MPI thinner.
You can observe this if you recall how the gap between ASI and MPI reduced recently.
Further if the size effect is still exists (no recent research on this was seen) , small caps should outperform large ones. In other words, ASI should grow at a higher rate than MPI. On this ground, passing ASI by MPI is not unusual.
At the moment I personally believe investing in small companies is rewarding (even though I do not like repeating posts on “gem talks”, most of gems they point out are small caps. This may explain why gem talks work at the end of the day).
However, this writing is not to say the size effect will be there in the market in future.
This is only an explanation on what was happened, NOT WHAT WILL HAPPEN. Keep it in your mind.
Finally, I do not see passing MPI by ASI is a reason to market goes down.
Any other different view point?
Regards
Academic
ReferencesNanayakkara N.S., (2008), Three factor asset pricing model: Explaining cross section of stock returns in the Sri Lankan stock market, Proceedings of fifth international Conference on business Management, University of Sri Jayewardenepura, Sri Lanka.
Samarakoon, L. P. (1997). The cross section of expected returns in Sri Lanka. Sri Lankan Journal of Management, 12(3), 233-250.