Most signals point to deeper correction in equities, Nifty may hit 14,500

If Nifty breaches support levels of 15,600-15,700, the index could fall to 14,500 levels

The market trend has been quite bearish since mid-February. A sequence of adverse macro events has occurred, including the Ukraine war (which drove up energy costs for fear of supply disruptions), China lockdowns (which means downgrades to global growth projections), weak domestic demand, high inflation, and the Reserve Bank of India (RBI) hiking interest rates to combat inflation.

Foreign portfolio investors (FPIs) have been bearish for an extended period. They started selling rupee assets in October 2021. Since January this year, FPIs have sold Rs 2.48 trillion of Indian equity. This is one reason why the rupee has fallen from Rs 74.37 per dollar on January 3 to Rs 78.13 (an all-time low) on Monday.

The FPI selling has been balanced, however, by domestic institutional investor (DII) buying. DIIs bought Rs 2.01 trillion worth of equity since January 1. A considerable proportion of the funding for that buying has come from mutual funds, which have seen inflows of over Rs 97,000 crore into equity funds (January-May).

Given the dip in stock prices, one may assume that direct retail investors and high networth individuals have been net-sellers this year. We’ve also seen signs of weaker sentiment, with the Life Insurance Corporation of India’s mega issue and earlier initial public offerings of Zomato and Paytm trading down after listing.

Technically, the Nifty has reacted by about 15.5 per cent from its record highs of 18,604 points in early October. This year, the index is down 11 per cent. At its current levels of 15,744, the Nifty is well below its own 200-day moving average (DMA) and its 100-DMA. A break-down below 200-DMA is generally considered a reliable signal of a long-term bear market.

In terms of fundamental valuations, the Nifty is now trading at a price-to-earnings (P/E) of 19.5 (taking the last four quarters earnings) – that’s roughly an earnings over price yield (inverting the P/E ratio) of 5.2 per cent.

The benchmark 10-year government securities is trading at a yield of 7.6 per cent and the debt market is braced for further monetary tightening by the RBI, which implies that debt yields could rise further.

When risk-free assets are available at higher yields than equity earnings, the stock market tends to move down, unless there’s a big acceleration in earnings per share (EPS) growth.

There seems to be little chance of a surprise jump in profitability, although there may be a low-base effect augmenting earnings in the first quarter of 2022-23 (FY23), compared with April-June 2021 (when the second wave impacted activity).

Most analysts expect aggregated EPS growth in the region of 15-16 per cent in FY23, given the current inflation and gross domestic product growth projections. This level of growth is already more than fully discounted by the current P/E ratio.

Most of the signals – macro, technical, and fundamentals – therefore, seem to indicate deeper market corrections more likely than a bounce from these levels.

Beginning April 2020, an extraordinary bull market has been witnessed. Historical patterns suggest a correction could be correspondingly severe. Big Indian bear markets as in 2001 and 2008 have often seen index corrections of close to 50 per cent or more, from the previous peaks. There’s support at 15,600-15,700. If that breaks, the market might dip all the way to 14,500.

While FPI sell-off has been massive, there are sectors where they continue to show interest. Looking at the assets under custody data of FPIs between May 15 and May 31, they have increased their exposure to automotive and automobile ancillaries, capital goods, oil and gas, and realty. These could be sectors that hold defensive value.