Indian markets go with the FII flow

“What we are seeing right now is a liquidity-driven rally, mainly because foreign institutional investors (FIIs) have made a comeback after a hiatus, and domestic institutional inflows have largely remained resilient,” Nitin Bhasin, head of institutional equities at Ambit Capital, said. FIIs have been net buyers of Indian equities for the fourth month in a row in June. In 2023 so far, they have pumped ₹63,482 crore in Indian stocks, showed National Securities Depository Ltd data.

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This is also feeding into mid and small-cap stocks. “What is worth noting here is that last year small-caps were beaten, and mid-caps were also stagnant; domestic institutions shunned them. But now, mutual fund managers have made a comeback as the prospects of these companies are improving mainly because reducing inflation will help,” added Bhasin. When interest rates are rising, mid-cap and small-cap stocks usually feel a greater heat than large-caps primarily because borrowing costs inch higher.

Little wonder that the fear gauge NSE’s Volatility Index (VIX) has cooled off. Similarly, in the US, the Chicago Board Options Exchange VIX has moderated. Clearly, there is increased complacency on the Street, but that does not mean there are no downside risks. On the contrary, there is a slew of them.

The risk of El Niño still looms. Back home, lower-than-anticipated rainfall could adversely impact agricultural output, thus hurting rural incomes and demand. Plus, tighter financial conditions and waning pent-up demand could have a bearing on urban consumption as well.

After global IT giant Accenture’s latest earnings last week, there are heightened concerns about a deeper slowdown for the Indian IT sector. Globally, in a turn of events, the US Federal Reserve is now expected to raise interest rates by another 50 basis points (bps) in this calendar year. If this plays out, then the Reserve Bank of India (RBI), which has maintained a status quo on rates, might have to budge.

“If the US Fed raises rates by another 50 bps, then RBI might need to raise by another 25 bps so that the relative attractiveness of Indian bonds and currency carry trade is maintained,” said Kunal Vora, head of India equity research at BNP Paribas. He cautions that a further hardening of the US bond yields and accelerated pace of quantitative tightening can be a potential global risk in the current backdrop of a liquidity-led rally.

So, it would not be prudent to get carried away only by fund inflows. “In our view, it would be best to ignore flows as any sort of investment guide or tool,” analysts at Kotak Institutional Equities said in a report on 21 June. This is especially true in the current context, as the bulk of FII and domestic flows seem to be of the ‘passive’ variety, and active investors would not want to be guided by passive investors for investment decisions.

Also, at times like these, a runaway rally in some stocks could be enticing. But according to Bhasin, investors should be selective while investing in mid and small-caps because, in this kind of market up-move, fundamentals tend to get ignored.

Amid this, note that India’s valuation multiple is rich, and it continues to trade at a premium to Asian peers. So, investors better not get too comfortable.

Updated: 26 Jun 2023, 12:42 AM IST