FPIs’ bear flip may maul markets more

Foreign portfolio investors (FPIs) have flipped their bullish derivatives bets to bearish ones over just two trading sessions. This swift change of view raises fears of a deeper retracement from the markets’ recent peak. In these past two sessions, FIIs sold 20,384.2 crore of cash shares, turning net sellers of 3,852 crore so far this month.

The National Stock Exchange’s Nifty marked a life high of 22,124.15 points on Tuesday, when FPIs held a cumulative net bullish position of 79,599 contracts in index futures (Nifty and Bank Nifty). However, they unwound all their bullish bets and turned net short by 4,659 contracts on Thursday, coinciding with the market pulling back almost 3% from the high to close at 21,462.25, thanks to a bloodbath in HDFC Bank Ltd shares.

A pullback or retracement is defined as a fall of 5% from the peak; a correction is a slide of 10-20%. A bear market happens when prices fall below 20% from the peak.

Analysts expect foreign investors to increase their short positions in the forthcoming sessions, adding further volatility to the market. Whenever this has happened in the past, markets have tended to correct and bounce back only when they hit extreme short levels (see table).

For instance, on 2 November last year, FPIs held net cumulative short positions of 175,698 on index futures and the Nifty traded at 19,133.25. From here, they covered the bearish bets and by 21 December held a net cumulative long position of 89,782 contracts, by which time the Nifty had risen to 21,255. But now, they have turned negative and clients—retail and high net-worth investors—have become positive.

While a bounce-back can’t be ruled out after the sharp fall over the past two days, the near-term trend could be downward if FPIs sell in cash and index futures, analysts feared.

“There could be still more short creation by FPIs and more downside in store, interspersed by bouts of volatility,” said Abhilash Pagaria, head of quant research at Nuvama Wealth. “Though a bounce is possible, the texture right now looks weak for the near term with the market likely to trade in a 21,000-21,800 range. We are somewhere in between this now and there is space for a further pullback.”

The steep rise in the Indian markets until recently has been driven by solid domestic and foreign institutional investments. FPIs net invested 1.71 trillion in Indian shares in 2023 while domestic institutional investors pumped in 1.85 trillion. The flows have driven the one-year forward valuation premium that MSCI India trades at to MSCI China to a historic high of 171.26%.

“But, with high valuations, there is no tolerance either for corporate governance issues or slip in performance, as seen in the case of Polycab Cables earlier and HDFC Bank, in terms of disappointing Q3, for the latter,” said Deven Choksey, managing director, KRChoksey Shares and Securities. “The global funds who are entering the Indian markets have a trader mindset and this is showing in the drubbing in some counters. That is why we are seeing positions flip rapidly.”

HDFC Bank, which has fallen 11.5% in the past two days, saw a massive build-up of short positions in the active call option contract of 1,500 level, which means it is likely to remain under pressure in the near term.

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