“Go Long:” Reasons Why The Indian Stock Markets Are Poised For A Sharp Rally

To long, or to short, is the question weighing on the minds of most stock market traders in the current scenario. “Go long,” says Rohit Srivastava, founder, of Strike Money Analytics and Indiacharts.

After the recent sharp rally since the beginning of 2023, the global stock markets and financial industry are yet again facing two horns of a dilemma: Geopolitics due to the war in the Middle East and the rout in the US bond markets.

For over three decades now, Srivastava has been charting India’s stock markets vis à vis the global assets including derivatives, bonds, currencies, commodities etc. and has been a witness to several market cycles. In his view, the US bond market rout is at its peak now and in the phase of final panic. This, he says is positive news for the stock markets and huge buying from long-only equity funds will emerge from here on.

If Srivastava’s view is correct then the markets are at the cusp of another leg of a major bull run with foreign portfolio investors (FPIs) having missed the bus and caught on the wrong foot with high levels of short positions in India. Index futures short positions of FPIs stood at more than 85,000 contracts at the start of the week. As the FPIs come to cover their short positions and go on to add new longs, the markets would rally.

Since Israel and Palestine have fought several wars in the past three decades and the recent Russia-Ukraine war did not deter the markets, the geopolitics surrounding the war is currently being discounted by the experts unless multiple countries jump into the inferno.

Srivastava’s take on why the markets are  poised for a rally:

The US bond market turmoil is in the final phase of panic. Charts for the US 10-year note and 30-year bonds both have oversold readings on daily, weekly and monthly charts. This is also accompanied by the highest short position in the futures market for these bonds. The sentiment is at a low where only 8-9 per cent of traders are bullish on US bonds (Daily Sentiment Index – DSI). This combination is for the bond market collapse to come to an abrupt and then turn around into a massive short-covering move in the bonds.

Should the traders play a wait-and-watch game then?

The wait is over. Two months of zig-zag movements between 19900-19300 in the Nifty amount to one long consolidation period. In the meantime, the negative sentiment in US equities has reached a level similar to Jan 2023 when the chips were down. This is based on the CBOE (Chicago Board Options Exchange) put/call ratio that has recently spiked back to the levels seen at the beginning of the year when markets started their upward journey in the US. With the two-month correction in the US also taking sentiment back to the bottom of the pit, I believe it’s time for global equities as a whole to take off to new heights.

In the US too, extreme bearish sentiments were recorded, which is often the reason behind reversal in the markets. There is a view that any relief from the bond market will lead the dollar to further accentuate the trend of short covering.

Extreme short positions in the US

In May 2023 large speculators held more than 400,000 contracts short in S&P futures (Commitments of Traders Report from the Commodity Futures Trading Commission), now that number is near 73,000 contracts. A huge reduction has already occurred but traders are still short and sentiment negative.

In the next rally, sentiment should turn on its head with short converting back to long positions. That is the nature of markets.
 
Market tops are not made on negative sentiment but extreme optimism and we are nowhere close to optimism on any data point. For example, in India, the number of Puts trade v/s number of calls traded daily (volume Put/Call ratio), remains at elevated levels for months together. These levels have historically been associated with a bottoming market.

This time round the data is not cooling off at all despite the Nifty going to all-time highs. It suggests that traders remain extremely cautious and bearish on Indian equities even after Nifty has rallied from 16800 to 20000. This has to change before we can think about a market top. Therefore, it is my assessment that we are set to take off to new highs in a powerful rally that will change sentiment meaningfully.

The US bond market sell-off is linked to the idea that inflation will remain strong for longer and that will result in higher interest rates remaining for longer. But Growth+Inflation is a very bullish combination for equities even though it means interest rates remain higher for longer. This can delay the much-awaited slowing and landing of the economy that analysts are waiting for. So the bulls have a lot in favour of them at the current juncture due to the invisible hand of the government that was prescribed by Keynes almost a century ago

Are India’s market valuations not concerning?

“FPIs have surprised Indian markets. Selling over Rs 20,000 crore worth of stocks month after month even as earnings grow in the 20-30 per cent range for Nifty companies, is unthinkable. Narrowing of the interest rate differential is not the only factor here, but a perceived currency risk. The US dollar has also been strong aiding this anxiety. In index futures FPIs have swung from a short position in August to a Long position by mid-September and a short position again as we enter October. I will not be surprised that we witness a rally on short covering again,” Srivastava says.

Small and mid-cap rally to continue

Rightly so. The small and mid-cap indices or the stocks have not witnessed any major fall in the past couple of months even as the benchmark indices Sensex and Nifty came under FPI selling pressure somewhat. India strategy report by Motilal Oswal says, “healthy momentum in corporate earnings, strong retail participation, higher flows towards mid- and small-cap funds post their outperformance in 1QFY24, all-time high SIP flows and relative underperformance of large caps in the last few months have fueled the rally in mid-and small-cap companies in 2QFY24 (second quarter of financial year 2024) as well.”

The Midcap100 and Smallcap100 indices have risen 29 per cent and 31 per cent, respectively, whereas Nifty has been up by only 8 per cent in 2023 so far.

Valuations-wise, the range for Indian equities has changed and will stay elevated given that we are moving into a lower interest rate environment and are also witnessing one of the highest rates of growth in both GDP and earnings in the world right now. India therefore deserves the earnings premium and it is unlikely to go away in a hurry.