The Indian equity markets struggled to attract retail investors in February with cash volumes stagnating. Despite the rebound in trading and Adani Group company share and banking stock volatility after the budget, the combined average daily trading volume in the cash segment of both the National Stock Exchange of India and the BSE increased by only 3.97 per cent.
However, the average daily trading volumes in the futures and options (F&O) segment reached a record of Rs 204 lakh crore, which rose from Rs 202 lakh crore in January. Interestingly Mutual Fund volumes continue to scale up, pointing to different ebbs and flow in the investment industry. We will explore this in this post.
Factors Hindering Retail Participation
Retail participation remains low due to expensive valuations and fears of a potential cut in earnings in the upcoming March quarter. Additionally, concerns over below-normal monsoon rainfall amid possible El Nino conditions are increasing worries about rising food inflation. These micro and macroeconomic headwinds are contributing to selling pressure, with analysts observing that the markets are experiencing downward pressure on each high.
Some of the factors holding back retail investors are the decline in midcap and small-cap stocks, the rout in Adani Group stocks, and the lack of initial public offerings. The volatility is expected to slow the pace of demat account openings, even though about 2.2 million accounts were opened in January compared with 2.1 million in December.
Equity Market Performance
In February, midcap and small-cap stocks declined 1.7 per cent and 2 per cent, respectively, following drops of roughly 2.7 per cent and 2.5 per cent in January. BSE small-cap stocks have fallen by an average of 23 per cent from their peak in October 2021. Of the top 500 stocks, 70 of them, or about 14 per cent, are currently trading 50 per cent lower than their respective highs in 2021. Conversely, 121 of the top 500 stocks, or 24 per cent, are trading at a higher value than their 2021 highs.
Poor breadth remains a major issue in the market, and the downtrend in stock prices has affected the morale of retail traders. The failure of a well-known group has led to sharp losses, and many traders are still nursing their recent bruises. Domestic institutions and high-net-worth individual investors are gradually absorbing the supply of stocks by foreigners. All the aforementioned factors have affected cash market volumes on the exchanges.
Foreign Portfolio Investors (FPIs) Sell-Off Spree Continues
Foreign investors have turned cautious and pulled out in excess of Rs 2500 crore from Indian equities just ahead of the release of the Federal Reserve’s latest meeting minutes.
This marks the worst outflow in the last seven months, as per data from the depositories. The pullback from FPIs in February comes after a massive sell-off in January when they took out Rs 28,852 crore from the Indian equities market. However, the pace of selling has come down in February, indicating a slightly less cautious stance by FPIs.
The sell-off by FPIs can be attributed to a variety of reasons, including rising rates in the US, which may lead to more capital outflows from emerging markets like India. Additionally, concerns about inflation and the release of the Federal Reserve’s latest meeting minutes may have contributed to FPIs taking a cautious approach towards Indian equities.
The withdrawal by FPIs has also been driven by disappointing economic data in India, such as the slowdown in GDP growth and the contraction in the manufacturing sector. This has led to concerns about the country’s economic recovery and potential impact on corporate earnings.
While the sell-off by FPIs has had a negative impact on Indian equity markets, experts believe that the impact may be short-term in nature. As central bankers pause their interest rate hikes in the second half of the year, corporate India is expected to continue performing well, with earnings on the rise. This is expected to make valuations more attractive, potentially leading to a recovery in the stock market rally.
Mutual Funds Continue Inflows
Despite the highly volatile conditions of the stock market, Mutual funds in India have been seeing consistent inflows. In February 2023, AMFI reported a net inflow of ₹9,575.17 crores despite the Nifty 50 falling by 2%, marking its third consecutive monthly decline. Similarly, Sensex tumbled by around 1%. However, the mutual funds market has shown a positive track record of inflows for the past five consecutive months.
Equity Mutual Funds Remain Popular Among Investors
Equity mutual funds have remained among the most preferred investment mechanisms for investors during this volatile market scenario. The latest AMFI data shows that inflows in equity-oriented mutual fund schemes in February 2023 came in at ₹15,685.57 crores. Healthy net inflows in equity MFs have lifted the overall mutual fund market. Thematic/sectoral funds stood out with the highest inflows in four months, clocking ₹3,856 crores.
Debt-Oriented Mutual Funds See Drop in Inflows
While equity-oriented mutual funds have seen strong inflows, debt-oriented mutual funds have witnessed a drop of ₹13,815.23 crores in terms of inflows during February. Investors are churning their allocation between short and long-term funds as interest rates are expected to rise from current levels. Liquid funds outflows were the highest at ₹11,304 crore, followed by Ultra short duration funds at ₹2,430 crore and Low duration funds at ₹1,904 crore.
Net assets under management (AUM) stood at ₹39,46,256.95 crore as of February 2023. However, on a year-to-date basis, Nifty 50 is down 3.93 per cent, with Nifty junior down 10 per cent and Nifty bank down 5.8 per cent. With banking and large-cap companies dominating the portfolios of many mutual funds, the returns were subpar over the last few quarters.
Central bankers have been compelled to increase interest rates due to the impact of rising inflation on the economy. However, this cycle of raising interest rates is expected to pause in the second half of the year. In the meantime, corporate India is expected to continue performing well, with earnings on the rise. This will likely make valuations more attractive, resulting in a potential stock market rally.
While the sell-off by FPIs highlights the impact of global factors on emerging markets like India and the near-term outlook may remain uncertain, the long-term growth prospects of the Indian economy remain strong. Investors may want to keep an eye on the market for potential buying opportunities.
We opine that as prices begin to trend higher, retail traders are expected to re-enter the market, leading to a recovery in volumes. The long-term investor can take advantage of any of these dips to keep adding to fundamentally strong companies.
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