Short covering and foreign inflows are fuelling Indian stock market rebound | Expert Views

In the three weeks to November 13, the Nifty 50 surged 11.3 per cent, from 22,600 to 25,144, with almost all the gains concentrated in a single spectacular week. Between October 30 and November 6, the benchmark rose 8.6 per cent, its strongest weekly performance in roughly six years. Five forces converged. One, the government hinted that it would consider removing the main irritant for FPIs — long-term capital gains tax. Two, the unwinding of the crowded AI trade in other Asian markets encouraged FPIs to diversify towards India. Three, a sharp fall in prices of crude oil improved India’s external economic prospects. Four, by late October, FPIs had built huge bearish positions in index futures. The rally triggered by FPI buying was turbocharged by powerful short-covering. Five, better corporate earnings provided fundamental support. After months of selling, overseas investors bought Indian equities worth $6.43 billion up to November 12, their biggest monthly purchase in more than two years. 

Of the five reasons, the global retreat from the AI trade is the most amusing. In my piece in August, I had argued that the biggest reason to ignore the FPI griping was that India’s listed stocks had little exposure to the current AI mania. That gripe ignored the fact that only Taiwan and South Korea, among countries outside the United States and China, could offer significant exposure to the AI fashion. I had said that no policymaker should lose sleep over this. It would be akin to shunning a country in 1999 because it did not have loss-making listed internet companies, or in 2007 because it did not have financial stocks minting money from toxic subprime mortgages. From the second week of October, American AI stocks, semiconductor makers in Taiwan and South Korea, and suppliers of data-centre infrastructure began a deep dive as investors started to question whether these represented an expensive wager on returns that had yet to materialise. In October, foreigners withdrew nearly $50 billion from seven Asian equity markets, much of it from Taiwan and South Korea. India, with little exposure to the semiconductor supply chain, became a destination for investors seeking diversification. 

Meanwhile, Brent crude, which approached $113 a barrel on October 30, fell by about a fifth from its peak before trading near $92 on November 12. The decline reflected reduced fears of further escalation in the Iran conflict and hopes of de-escalation after America’s midterm elections. For India, which imports close to 90 per cent of its oil, the benefits are immediate: A smaller import bill, less pressure on the current account and the rupee, and lower imported inflation. The rupee strengthened by about 1.1 per cent in the week to November 6, its best weekly performance since April. A firm currency makes Indian assets less risky for dollar-based investors, creates a virtuous circle of lower oil prices, a steadier rupee, and renewed inflows. The markets were pricing in a greater chance of deescalation, not settled peace. 

The speed of the advance owed much to the unusually large bearish FPI position in Nifty futures, with net shorts estimated at around 280,000 contracts near October 23. Once the index rose, those bets became costly. Investors who had sold futures had to buy them back, adding demand just as cash-market buying gathered pace. By November 6, net shorts had fallen to about 100,000 contracts and Nifty futures open interest had dropped by roughly 22 per cent. Foreign investors were also net buyers of about ₹27,600 crore of index futures over seven trading sessions to November 12. This was a classic short-covering episode, further amplified by substantial actual purchases of shares in the cash market. Of the 50 Nifty companies reporting results, 27 beat analyst estimates. Sales and operating profits rose 22 per cent. Foreign buying is usually concentrated in large, liquid companies, particularly financial stocks, whose weighting in the Nifty gives each rupee of demand an outsize influence. In the first week of November, Shriram Finance rose 16.8 per cent, Bajaj Finance 15.8 per cent, Mahindra & Mahindra 15.7 per cent, HDFC Bank 13.8 per cent, and Reliance Industries 13.3 per cent. 

What comes next? A powerful rally after a long period of listlessness can set the stage for a prolonged rise, the reasons for which are sometimes unfathomable. From a deeply pessimistic market in late December 2011, the Nifty staged a remarkable seven-week rally of 21 per cent up to the third week of February 2012, with no clear explanation. It is quite another matter that over the next three months almost all the gains had been wiped out. There is no way to tell whether this is the beginning of another long bull market, particularly if the stalemate in the Strait of Hormuz remains unresolved. However, I remain bullish on smaller Indian companies and the domestic fund flows that support them. This is a durable trend which I have highlighted several times this year.

The writer is cofounder of www.moneylife.in and a trustee of the Moneylife Foundation; @Moneylifers