Soaring crude just one of the worries; crowded Modi-win trade, wary smart money may keep D-Street bulls in check

daily turnover in NSE MidSmall cap 400 stocks was in the range of Rs 55,000-65,000 crore earlier this year.

Fresh outbreak of hostilities in the Middle East following Iran’s attack on Israel, is likely to keep crude prices high in the days ahead. Some analysts have warned that crude could hit $100/barrel by May. That is bad news for India’s current account deficit, and by extension, the rupee. Also, for corporate earnings as inflation increases input costs and hurts demand. This could put brakes on the ongoing stock market rally, even as majority of the bulls are confident that strong domestic money inflows and an emphatic win for the BJP-led NDA coalition can solve everything.

The Nifty may be hitting new highs, at the same time there are factors at work that could limit big upsides from current levels. Here’s a look at them:

Choosy foreign investors

FIIs have net bought shares worth Rs 24,000 crore so far in 2024. But market observers point out that the bulk of the purchases have been through large block deals. Shows foreign funds are selective about what they are buying.

Regulatory glare

India has recently plugged a key loophole in its Double Taxation Avoidance Agreement with Mauritius through an amendment. There is uncertainty about whether the amendment will apply to investments pre-2017 when the rule on capital gains tax had first been changed. The current tweak will most impact FDI investments coming through Mauritius, but there are concerns that other tax havens too will come under increasing scrutiny.

Crowded Modi-win trade

The widely held view on the street is that the NDA coalition will sweep to power with a massive majority in the general elections, and the market will rally on the news. So, an ideal strategy is to hold on to the winning positions right now, maybe even buy some more, and sell when the elections results are announced. The hole in this argument is that too many people are trying to play this trade. If everyone wants to sell post-elections, who will buy?

Besides, the Street seems to be completely ignoring the possibility that election results may not meet market expectations.

F&O open positions

The value of the open positions held by retail investors in single stock futures has risen sharply. Aggregate value of open positions across all investor categories has now gone over Rs 2.2 trillion. Of this 77 percent of the long positions are held by retail investors. This is a cause of worry, according to market veterans, because retail investors are the first to panic in the event of sharp market moves.

Domestic institutions are net short in single stock futures, accounting for almost all of the short trades. Ideally, that should act as a cushion in the event of a market fall. But the catch is that the majority of these short positions are one leg of an arbitrage trade. When they square up the short positions, they will also sell shares they have bought in the second leg of the trade.

Shrinking turnover

While mid-cap and small-cap indices have been making new highs again, traded turnover is below the levels seen during the earlier peak in January and early February. For instance, daily turnover in NSE MidSmall cap 400 stocks was in the range of Rs 55,000-65,000 crore earlier this year. That has fallen to Rs 40,000-45000 crore over the last month.

Market watchers say HNIs are holding back from big purchases as they feel valuations are expensive. However, retail investors continue to be bullish, unmindful of valuations.

Curbs on NBFCs

Following the joint action by RBI and SEBI last month which led to restrictions on NBFCs IIFL Finance and JM Financial, leveraged bets by HNIs have reduced. That is because NBFCs are not as generous with the overdraft limit to clients as they had been before the regulatory crackdown.

Perma bull mutual funds?

Another widely held theory is that strong SIP inflows into mutual funds will keep stock prices higher as fund managers will have no choice but to put the money to work by buying stocks. A logical argument, but it overlooks the problem of expensive valuations. If mutuals funds keep buying, they may end up providing an exit to another set of smart money—FIIs, HNIs etc—who find the valuations rich.

As the April inflow numbers show, mutual funds have slowed down their pace of purchases.