Stocks brace for volatile month amid bearish FPIs


Indian stocks may witness wild swings this month, with foreign portfolio investors (FPIs) turning bearish on both the cash and derivatives segments of the National Stock Exchange (NSE) amid lofty mid- and small-cap valuations, rising US interest rates and bond yields, and the threat of oil prices hitting $100 a barrel.

FPIs turned net sellers of 14,768 crore in NSE’s cash market in September after buying equities worth 1.69 trillion over six straight months. Simultaneously, they held a cumulative net short position in index and single-stock futures as of 29 September, coinciding with their cash market sales.

Their cumulative net shorts in index futures (Nifty and Bank Nifty) contracts stood at 72% and in single-stock futures contracts at 53% at the beginning of the October series of derivatives contracts. Against this, they began the September series with 51% cumulative bullish positions in index futures and 52.8% bearish bets in single-stock futures.

Derivative contracts expire on the last Thursday of each month, with a new series starting the following day. If Thursday happens to be a holiday, the contracts expire a day prior.

Unlike at the beginning of the previous series, the difference in the current series is that FPIs are bearish on both cash and derivatives segments. This could increase the volatility in markets in October compared to previous months, analysts said.

“In index, FPIs are taking short bets and have increased shorts in SSF (single-stock futures) marginally,” said Abhilash Pagaria, head of Nuvama Alternative & Quantitative Research. Pagaria said that high-net-worth individuals (HNIs) and small retail investors were counterparties to the foreign institutional investors (FIIs), buying what they were selling in index and single-stock futures and in cash.

HNIs and retail investors, described as clients by NSE, hold cumulative net bullish positions of 60% in index futures and a whopping 90% long in single-stock futures. Apart from FPIs, domestic institutional investors (DIIs), including mutual funds (MFs) and insurance companies, are hedging their long cash portfolios by shorting index and stock futures.

“Clearly, the FPI shorting in cash and derivatives will make the market choppy,” said Nilesh Shah, managing director of Kotak Mahindra Asset Management Co. Ltd (Kotak AMC). “The rise of oil by 25%-plus since July to date, lofty valuations in mid-cap and small-cap stocks, rising US bond yields, which are leading to outflows from EMs (emerging markets), are risks to the upside.”

Bond yields in the US are inverted, with the two-year US treasury at 5.05% currently and the benchmark 10-year at 4.57%, which shows more money flowing into the longer-term bond. With the US Fed likely to keep interest rates higher for longer to bring inflation back to the 2% target from 3.7% currently, the rate differential between the US and Indian 10-year benchmark bonds would further compress the risk-free rate of return from India, leading to outflows.

Also, the Nifty Midcap 150 is trading at 26.77 times the trailing price-to-earnings multiple, while the Nifty Smallcap 200 is at 24.54 times against the Nifty’s 22.21 times. This puts the mid- and small-caps at a higher risk of correction.

According to Goldman Sachs, India has underperformed peer markets comprising the MSCI Asia Pacific ex-Japan index during most sharp oil rallies, giving a negative six-percentage-point return in dollar terms on a median basis whenever oil has rallied more than 20% above $70 a barrel since 2008.

Since 10 July, Brent oil has risen by 26% through $92.13 a barrel and could increase more with Saudi Arabia and Russia extending voluntary output cuts by a combined 1.3 million barrels a day through December, which comes on top of an output cut in April this year.

Around 85% of India’s oil needs are met through imports, and a rise to three digits or above could obviate interest rate cuts by the Reserve Bank of India, with inflation likely to remain above its 6% upper tolerance range for longer.

“Over $100-a-barrel oil could impact profit margins of OMCs (oil marketing companies), autos and aviation companies, and result in price correction in their shares,” said Rajesh Palviya, senior vice-president (research), Axis Securities.

To be sure, retail buying directly and through MFs has cushioned market corrections while giving exits to FPIs, said Kotak AMC’s Shah, citing the 18.4% fall in markets from 19 October 2021 to 24 June 2022 when FPIs sold shares worth 2.54 trillion. That fall could have been far worse had DIIs not absorbed the FPI selling.

This time around, too, DIIs have turned buyers into cash since August after three months of outflows. Indeed, in September, they invested 14,849 crore while FPIs sold 14,768 crore, driving the Nifty index to a record high of 20,222.45 in mid-September.

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