Dark clouds over the Street as sentiments sour

Indian stocks may face choppy weather this week after foreign investors' sentiment soured across cash and derivatives segments on Friday, tracking weak global cues.

Apart from selling a provisional ₹3,310 crore worth of shares on Friday, FPIs purchased an additional 330,936 index put contracts (Nifty and Bank Nifty) overnight, taking their net total put contracts held to 473,635. Additionally, they cut their net cumulative bullish index futures positions by 21,170 contracts to 145,109 from 166,279 contracts on Thursday.

This negative sentiment was reflected in the domestic market on Monday morning, as India's frontline indices tumbled nearly 3%, their steepest intra-day drop in two months, amid a global sell-off driven by fears of a US economic slowdown. 

Market volatility surged to a two-month high, with fear gauge India VIX soaring 42% to a nine-year high. All 13 major stock sub-indexes were in the red, with the metal index leading the decline at 5%. Small-cap and mid-cap indexes each retreated over 2%.

The rupee hit a record low, and bond yields fell to their lowest levels in two years.

Tracking the 1.8% fall in the S&P 500 and the 5.8% fall in the Nikkei 225, the Nifty and the Sensex, which closed over a percent lower on Friday, could remain under pressure at opening this week, market experts said.

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"Global reverberations are bound to be felt by us, as our markets are on high altitude in terms of valuations and expectations," said Nirmal Jain, founder of IIFL Group.

Jain said Indian retail investors should remain "conservative," avoid "leverage" and "dabbling" in derivatives against the "current backdrop of heightening volatility. "

While Nifty has risen 13% from 21884.5 on 4 June, the election results' day, to 24717.7 on Friday , its trailing price to earnings multiple has jumped to 23.09 times from 20.81X over the same period.

Surge in unemployment

Unemployment in the US surged to a near three-year high of 4.3% in July from 4.1% in the preceding month, raising concerns that the US Fed will have to ease rates at a faster clip to avoid a hard landing. The Bank of Japan, on the other hand, raised its short-term policy rate to 0.25%, the highest in 17 years, in a bid to reduce mounting public debt. Also, escalating tensions in the Middle East could cast a shadow.

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"This hike by BoJ is adding to the negative foreign portfolio investors (FPI) sentiment here, as it means that people who borrowed cheap in Japan to invest in risky high-yielding shares of emerging markets would have to unwind these trades," said Andrew Holland, CEO, Avendus Capital Public Markets Alternate Strategies.

Nifty options expiring on 8 August (coming Thursday) show that option sellers expect the index to trade over a 2.54% range from 24,700 this week. The support lies at 24,386, while the resistance is at 25014.

Pressure on retail investors

Increased FPI selling could also pressure retail investors who use short-term loans from brokers to buy shares.

While secondary market activity for retail investors on NSE, the country's largest stock exchange, was not available for the current month, the margin trade funding (MTF) book outstanding at brokers' end was at a record ₹74,180.8 crore.

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MTF allows investors to meet any shortfall while purchasing shares by borrowing short term from brokers who charge interest from clients in the form of cash or shares.

This book is already under pressure ,with NSE removing over 1,000 stocks as collateral for margin funding. A pullback in markets due to weak global cues could also result in trades being unwound by some retail investors, feels Rajesh Palviya, SVP, derivatives & technical research head at Axis Securities. He said this could happen if the markets slip below the Nifty's 20-day exponential moving average of 24548.