Horror show on Dalal Street as US, Japan spook investors

Tremors from Tokyo joined fears in the US to wreak a perfect storm on Monday, leaving a sea of red over stock markets worldwide.

Volatility shot up the most in nine years and Indian stocks tanked the most in two months, after the unwinding of yen carry trade and fears of recession in the US sparked selling across markets. Bloodied by losses in markets like Japan, South Korea and Taiwan, foreign investors pressed the sell button in India, singeing investor wealth by a steep ₹15.4 trillion.

Domestic institutions stepped up to counter sales by foreign investors; however, profit-taking by investors who route money directly into markets worsened Monday's fall. How retail investors behave from now—through mutual funds and direct investments—will be key to ascertaining whether Indian markets can outperform global peers, market experts said.

 

“While headline indices trade at fair value, mid-caps and small-caps trade way above their historic valuations and could face the music for longer, unless non-institutional investors, routing funds directly or through mutual funds, restart buying," said Sanjeev Prasad, co-head, Kotak Institutional Equities.

Carry trade unwinding

The yen carry trade—borrowing in cheap yen and investing in higher-yielding assets in other markets—is unwinding after the Bank of Japan last week hiked a short-term interest rate to 0.25% from 0-0.1%, the most in 16 years. This has strengthened the yen against the dollar, forcing investors leveraged by yen to unwind trades globally. Meanwhile, unemployment in the US rose to a near three-year high of 4.3% in July, raising concerns of a recession.

The benchmark Nifty and Sensex fell by 2.7% each to 24055.6 and 78759.4, while the Nifty Midcap 150 and Nifty Smallcap 250 tanked by 3.5% and 4.18%, as FIIs sold shares worth a provisional ₹10,073.75 crore. Provisional buying of ₹9,155.55 crore by domestic institutions was just enough to help markets recover from the day’s lows.

Also read | Yen yorker: What is the 'yen carry trade’ that’s causing a global stock rout?

The pullback wiped out ₹15.41 trillion of investor wealth, the worst since 4 June’s ₹31.06 trillion erosion on election results day. The rupee fell to a record low of ₹83.85 to the dollar, thanks to FII outflows.

While the Nifty appears reasonably valued, trading at a one-year forward price to earnings multiple of 23.59 times compared to its five-year average of 24.68 times, the Nifty Midcap 150 and Nifty Smallcap 250, favourites of retail investors, are very expensive, according to Bloomberg data. The Midcap index trades at a one-year forward PE of 44X (35.62) and the smallcap at 34.68 (28.34).

Unclear scenario

Whether Indian markets, driven predominantly by domestic retail flows, can be somewhat decoupled from global peers will be clear only in a couple of days, experts said.

“We have to wait and see whether retail resilience, seen post the elections or the budget, surfaces this time, too," Kotak's Prasad said in response to a query on how long he expects the turbulence to last.

Others too are of the opinion that coming sessions would chart the course for Indian markets, which have been powered by domestic flows in recent years.

Also read | Sebi's reforms to aid further retail participation in markets, say experts

“Tomorrow (Tuesday) will be a better day to judge if we are able to hold our own or keep falling with the rest of the world," said Swarup Mohanty, vice chairman & CEO of Mirae Asset Investment Managers (India).

Mohanty feels that the cuts in Indian markets were “relatively less severe" to those seen in Nikkei 225, Taiwan’s Taiex and Kospi, which tanked between 8% and 12%, with the South Korean benchmark witnessing a trading halt after falling over 8%. “Today’s sale (in India) is largely due to hot money outflows to make good losses in other peer markets," he added.

A further 5-7% correction could make the risk-reward ratio favourable for those investors looking to 'buy on dips', said Taher Shah, chief investment officer at Ivesco Mutual Fund.

On Monday, the top 5 drags on the Nifty included Reliance Industries, which contributed 79.59 points to the fall, HDFC Bank (73.95), Infosys (56.63) , ICICI Bank (38.12) and Larsen & Toubro (36.4). Ten stocks fell for every stock thatroseonNSE.

Figures on retail activity were unavailable until press time. Domestic institutions, led by mutual funds, net invested ₹1.85 trillion in 2023, while FIIs net invested ₹1.7 trillion.

Volatility jump

The nervousness was underscored by fear gauge India Vix, a measure of expected volatility, spiking 42.23% to 20.37, the most since a 64% jump on 24 August, 2015, consequent to a slowdown in China.

The rise in Vix means a jump in the price to buy protection in the form of put options, which insulates investors from a loss in their cash market portfolios.For instance, the 24000 put option expiring on 8 August, which cost just ₹13.45 a share (25 shares make a contract),on Friday closed at ₹185 a share on Monday, a 1275% increase.

The rise in price is because of Monday’s steep fall. Option sellers are wary of selling more puts as any fall while protecting buyers could expose them to huge losses. This is the reason they are demanding a high price for the put options.

Also read | Dark clouds over the Street as sentiments sour

“The yen carry trade unwinding and rising fears of a recession in the US have spooked FIIs who are increasing put option purchases to offset the fall in value of their portfolios," said Ashish Gupta, CIO, Axis Mutual Fund. “It might not be prudent to take a contra view to volatility at this stage though I think the massive move in Japanese stocks in the past two days could result in a near term pullback (recovery)."

Asked whether mutual funds would step up buying of the dip, Nilesh Shah, MD, Kotak Mahindra AMC, said any buying would be “gradual" and limited to defensives like pharma and consumer staples and select large cap PSU bank stocks. Shah said that while borrowing in yen by Indian hedge funds would be “limited," foreign funds with exposure to yen loans deployed in other markets were likely taking profits from their Indian investments to meet losses elsewhere.

Another market veteran Samir Arora, founder, Helios Capital, said a “clearer" idea on the course of Indian markets would emerge in a couple of days.