Cautious Investors Trigger Record Short-Selling Build-Up in Indian Markets!

Last week, foreign portfolio investors were seen building a record short position in the derivatives segment as traders decided to take directional bets. This came in the midst of a chain of events that have been putting downside pressure on the markets, including the Adani-Hindenburg issue, George Soros’s speech, and Putin’s speech.

Mutual Funds Outsmart Traders But Both Show Caution

Interestingly, mutual fund players have outsmarted traders this time around. Reports indicate that the average cash holding of the top 20 mutual fund houses by Asset Under Management (AUM) was at a 25-month high of 5.9 percent. This is a significant increase from the 3.1 percent cash holding seen in February 2022. While mutual funds are not typically known to time the market as efficiently as traders, both traders and investors have shown caution in the current scenario, which is a cause for concern.

Markets Rattled By Adani Issue And Lower-Than-Expected Earnings

The Adani issue has rattled the markets after a strong budget and they have failed to recover from it. Additionally, a lower-than-expected earnings season has kept the Indian market valuation high. The one-year forward price-earnings (P/E) multiple of the Nifty 50 Index is 18, which is almost 10 percent higher than the 10-year average P/E multiple of the index. Indian markets are trading at a 25 percent premium to other emerging markets, which is higher than the historical premium of 15 percent.

Structural Weakness In Market Depth

The market depth is displaying structural weakness, with mid-cap and small-cap stocks falling by as much as 25-30 percent despite the Nifty being only five percent from its peak. Some smaller stocks have even fallen by 70 percent. In the past two years, more than 500 stocks have fallen by 50 percent, and another 500 are down by 30 percent. Apart from a few index heavyweights, most of the market is in a bear market.

Global Markets Also Showing Fatigue

Global markets are also showing signs of fatigue. The US markets posted their biggest fall in 2023 on Tuesday, with a strong flash PMI reading forcing the Fed and other central banks in advanced economies to hold interest rates higher for longer. As Ajay Bagga has argued in his column, this “no landing scenario” is negative for markets because higher rates for longer increase the downside risks for equities, particularly for high-debt companies that will see higher interest payments for longer.

Retail Participation In Indian Markets

One of the other concerns is retail participation in the Indian market. Although their participation has come down in the cash market, it has increased significantly in derivatives. According to a SEBI report, active traders have increased by 500 percent since 2019, but only one in 10 is profitable, and less than one percent has been able to beat FD rates.

Tread Carefully

Given the cautious positions of mutual fund managers, the short build-up by traders, growing tension between the US and Russia, and the falling global markets, it is essential to tread carefully. Investors should keep a close eye on the developments and remain cautious until there is a clearer picture of the market’s direction.