Nifty, Sensex rally but institutions’ absence, retail investors short term trades may spell bad news

here has also been an increase in interest in smaller stocks recently. (Image: REUTERS)

While Sensex and Nifty near all-time highs, the pillars of Dalal Street are getting shaky as big money opts to stay out. Institutional participation, both foreign and domestic, is close to 14-year lows, while retail investors continue to favour short-term trades. This change in market dynamics could result in bad news in the event of a correction, creating liquidity scarcity, global brokerage and research firm JP Morgan highlighted in a recent note. Sensex and Nifty are near all-time highs once again. Earlier in April, the headline indices slipped just 5% from highs while India fought the second wave and lockdowns were re-imposed.

Retail comes in while institutional investors stay away

The brokerage firm said that institutional investor participation is low and aggregate daily volumes are up three times since 2014, implying that retail participation has increased dramatically. Daily transaction volumes on exchanges have doubled from late 2019, now almost three times over 2014 levels. “This indicates a very large increase in market participation by retail, high net-worth individuals, proprietary desks, corporates and other participants,” the report said.

On the other hand, FIIs have been net sellers for the first two months of this fiscal year. The outflows come after FIIs flooded domestic markets with money in the previous financial year. Foreign investors have taken the time to book profits after having pumped in a record amount of money into domestic stocks last year. Meanwhile, DIIs have pumped in some money recently but it comes after massive outflows in the previous fiscal year. 

Short-term trading gains momentum

Further, delivery volumes have continued to remain below pre-pandemic levels, while volumes of intra-day trading have doubled in three years. “A smaller portion of daily business is ‘delivered’, indicating an increase in short-term trading,” JP Morgan analysts said.

There has also been an increase in interest in smaller stocks recently. The percentage of daily volumes traded in stocks with market caps of less than $2 billion has doubled in a year. Historically, the percentage of daily volumes traded in smaller-cap stocks decreases as the market and companies grow. The report said that the financial year 2023 forecasts imply close to a 47% increase in nifty earnings over financial year 2020 actuals. While earnings expectations for nifty mid-caps are far higher, implying an 85% increase in earnings between the financial year 2023 and 2020. 

Additionally, the proportion of BSE 500 stocks delivering weekly moves of +/- 10% or more has also doubled through the previous year. Volatility has increased with India VIX now settling above 2019 levels.

These indicators hint the underlying market dynamics for domestic equity markets have been deteriorating. “We think the increased retail participation adds beta/liquidity risks to the Indian markets. A change in sentiment/decline in the headline index can lead to a quick withdrawal of non-institutional volumes,” the report said. The report added that rising inflation, slowing Chinese monetary conditions or increasing rates could act as catalysts for a stock market correction.

In such a scenario where liquidity risk could emerge as stock markets correct, JP Morgan said it is underweight consumer discretionary names. The brokerage firm believes interest rates will remain low and hence favours rate-sensitives such as banks, real estate and autos for the longer term.