High ADR signals broad-based market; investor appetite for riskier bets

The advance-decline ratio (ADR) for stocks traded on the BSE went past 1 for the first time in three months in July. A total of 1,888 stocks advanced, while 1,662 declined last month. So far this month, 2,419 stocks have advanced and only 1,288 have declined.

ADR signals market breadth. An ADR of more than 1 indicates that more stocks have gained than those that have declined. The improvement in the ratio is a sign that the market rally is getting more broad-based as investor appetite to take riskier bets is once again on the rise.

Between October 2021 and June 2022, the ADR has been more than 1 only on three occasions. Market players said flows by foreign portfolio investors (FPIs) turning positive has been a big sentiment-booster for markets.

Typically, FPIs dabble in the top 200 stocks as they prefer liquid names.

ADR improves only when there is strong participation from domestic investors.

“A weak ADR was due to persistent selling by FPIs. This led to erosion in the wealth of retail investors and affected their participation. But July was the first month when retail investors turned into net-buyers since October 2021 as FPI flows improved,” says Ambareesh Baliga, an independent analyst.

Last July, FPIs invested over Rs 6,800 crore in domestic stocks — their first monthly net-buying since September 2021.

“There was some significant market capitalisation erosion, which was reflected in the ADR.  The markets recovered somewhat tracking positive global cues as the US Federal Reserve (Fed) raised interest rates in line with expectations. Recovery in the Indian rupee, better earnings from India Inc, and return of FPIs with small investments in the domestic market also assisted investor sentiment. The domestic markets may rise further for a few weeks.  However, volatility with a downward bias may return to the markets,” says Chokkalingam G, founder and chief investment officer, Equinomics Research & Advisory.

The Nifty Midcap 100 and the Nifty Smallcap 100 rallied 12 per cent and 8.6 per cent, respectively. The gains follow sharp declines in the preceding two months.

In May and June, ADR had declined to 0.77 and 0.83, respectively, underscoring widespread pessimism in the market.

Following sharp rebound in the market, key equity gauges are trading at their highest levels since April. The market has moved from extreme pessimism in June to one of extreme optimism. Some believe the market is overlooking the crucial risks on the horizon.

“The Fed’s balance-sheet reduction plan and oil price will remain risk factors in the short term. The balance-sheet reduction will continue to strengthen the US dollar. A rising greenback is likely to weaken emerging currencies, discouraging FPI investments in emerging markets in the short term. Further, a rise in crude oil price will be a short-term risk factor since the domestic economy faces a high fiscal deficit, elevated inflation levels, and falling foreign exchange reserve position. The worst is not over yet,” says Chokkalingam.

Baliga, too, believes the market momentum could lose steam.

“One doubts whether an improved ADR will sustain. The June results have been decent, but margin pressure remains. Because of commodity prices and supply-chain issues, there was a higher degree of stocking than earlier. When commodity prices correct, you are losing out on inventory. And there are global headwinds. I do not see why there should be a bull run when these facts are staring us in the face,” he adds.