Reading the rally: It is still a see-saw stock market

Investors should be prepared for sudden shift in trends

The rally across emerging markets in the past eight weeks has reportedly been driven by hedge-fund activity. These entities often take extremely risky positions if they perceive changes in the stances of big central banks, or shifts in global macro variables. Foreign portfolio investors (FPIs) sold heavily between January and June. That was when it became apparent that the Fed and the European Central Bank would be tightening monetary policy, and the Ukraine war and China’s repeated lockdowns caused a slowdown and huge supply chain disruption. In July, FPIs started covering short positions as US inflation showed signs of moderation. They have continued to take long positions through August. The trends in Indian equity and the rupee reflect the shifts in FPI attitude. Between January and early July, FPIs collectively sold Rs 2.2 trillion of Indian equity. They have bought back stocks worth about Rs 0.5 trillion in the past four weeks.

The Nifty and Sensex lost around 14 per cent between January and mid-June. The major market indices have since recovered by 16 per cent from the lows. In July, the rupee hit an all-time low of Rs 79.99 versus the dollar (dropping below Rs 80 on an intra-day basis) and has since recovered slightly to Rs 79.87. It may be noted that the rise in the market indices is not backed by either corporate fundamentals or market breadth. The Q1FY23 (April-June 2022) results have not been reviewed very positively by market analysts. Despite looking good in comparison to the low base of Q1FY22, which was hit by the second wave of Covid, earnings and revenues have not rebounded strongly, and there have been across-the-board complaints by management about low demand and margin pressures due to inflation.

There have been more downgrades than upgrades in earnings estimates for 2022-23 and this is also reflected in poor market breadth. While the Sensex has rebounded by 16 per cent, the majority of the stocks have lost ground. Of the 500 stocks in the BSE 500, 265 have declined since June 17, when the Sensex and Nifty have bottomed out. There isn’t a great deal of corrective action equity investors can take under the circumstances, but they should continue to exercise caution. Investors should not be swayed by the gains recorded by narrow movements in the big stocks favoured by FPIs.

The Reserve Bank of India also needs to watch these moves carefully because of the impact on the rupee. FPI investments and divestments can be extremely volatile — these funds can move in and out of an economy at great speed. Large sales can put the rupee under pressure, while large buys can equally suddenly propel the rupee up. Movements on this scale — Rs 2.2 trillion sold in six months, and about Rs 0.5 trillion bought in a month — can cause huge currency swings and affect domestic businesses. Maintaining stability in the currency market can become extremely challenging for the central bank in such circumstances. Besides, all this is happening at a time when the current account is under pressure due to the spike in energy prices. Thus, while the central bank would have to navigate the situation carefully, investors should be prepared for further volatility and sudden changes in market trends.