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Five ominous signs that show market at risk of a major selloff

BSE Smallcap, Midcap indices are down up to 16%, while the benchmark Sensex is up 6%.

Updated: Jul 16, 2019, 01.35 PM IST
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Nifty is slightly oversold on a few indicators on the daily charts, even though it has been able to defend its 100-DMA on a closing basis so far.
NEW DELHI: For some time now, stock market’s volatility index India VIX has been signalling strong complacency among investors at a time when macro data has been signalling weakness in the economy, earnings have not been supportive of stock valuations and global macros are at best shaky.

There are other similar signs that show despite the optical resilience Dalal Street has been exhibiting, something is not right deep down.

The broader market has already been witnessing severe selling pressure amid concerns over a looming economic slowdown, liquidity crisis in the financial sector and moderation in consumption.

BSE Smallcap and Midcap indices are down up to 16 per cent in last one year, while the benchmark Sensex is up 6 per cent.

So, what are these signs telling us?

Pullbacks & falling open interest
Technically, Nifty is slightly oversold on a few indicators on the daily charts, even though it has been able to defend its 100-DMA on a closing basis so far. This is a positive aspect that can trigger some technical pullback in the market.

But every time the index has witnessed a pullback, there has been a drop in net open interest (OI). This indicates short coverings and absence of fresh buying. Besides, all the downturns have been met with a reduction in OI, which indicates unwinding of longs at higher levels.

“This picture must be taken cautiously,” says Milan Vaishnav, CMT, MSTA, Technical Analyst at Gemstone Equity Research and Advisory.

Weekly charts show Nifty is giving up after a seven-week consolidation in the 11,800-11,850 range. “This is a warning signal that any correction must not come as a surprise and any technical pullback, though likely, may not sustain at higher levels,” Vaishnav said.

Positive correlation between VIX and Nifty
The correlation between Indian VIX and Nifty50 is typically negative, as a rise in volatility turns investors cautious. But what’s playing out is the complete opposite. The correlation turned positive at the start of July, even as Nifty hovered around its all-time high mark hit on June 18, 2019.

Analysts find this complacency of market participants around Nifty’s near record level very discomforting. “This divergence is not a good sign,” said Sandeep Porwal, Technical Analyst, Ashika Stock Broking said,

Nifty currently hovers around the 11,550 mark. “In case of a breakdown below the 11,460-11,430 range, the selloff is likely to take it towards the 11,250-11,230 range or even towards its May low of 11,108,” Porwal said.

Some analysts, however, say the short-term correlation between VIX and Nifty is meaningless.

FII shift from equity to debt
Foreign portfolio investors, who poured nearly Rs 83,000 crore in Indian equity market since January this year, have offloaded shares of worth Rs 4,954 crore in July so far. However, they remain net buyers in the debt segment, at Rs 8,504.78 crore during July 1-12. With a 21 per cent gain, debt funds outpaced equity mutual funds in last one year, signalling a steady shift to the safety of debt.

Wide diversity in performance within Nifty
Equity benchmarks Sensex and Nifty are hovering around their all-time high levels on the strength of select blue chips. Only 17 Nifty stocks have delivered 10-65 per cent returns to investors in last one year, while 27 have plunged up to 75 per cent. The rest has remained flat.

Shankar Sharma, Vice-Chairman and joint MD of First Global, recently told ETNow that everybody is feeling that something is wrong here. The underlying corporate economics are looking terrible. “Narrow bull markets always end badly,” he warned.

Nifty PE ahead of earnings projection
Nifty’s price-to-earnings (P/E) ratio hovers near its all-time high of nearly 29 times at a time when the economy is struggling amid liquidity crisis and demand slowdown. An earnings disappointment in June quarter is bound to dent market sentiment.

According to Motilal Oswal Financial Services, the risks to earnings remain tilted towards downside, given the weak underlying demand scenario and lack of private capex. The earnings growth recovery in FY20 is likely to be narrow and led predominantly by financials, even as global cyclicals remain a drag and consumption-oriented sectors are showing a deceleration in earnings.

“Nifty valuations are rich and offer limited room for re-rating,” the brokerage said.
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