Record-breaking stock rally pushes back hawkish Fed

Mumbai: Almost a generation of market participants have been trained to abide by the golden rule: don’t fight the Fed. But, an army of investors and traders these days is defying this tenet, even as the American central bank retains its hawkish policy tone. The Sensex and Nifty on Friday closed at record levels just a couple of days after the US Fed Chair Jerome Powell dashed hopes of any immediate reversal in the interest rate hike cycle,signalling it won’t back off from its fight against inflation even if it means a sharp downturn..

Ideally, such a Fed commentary should have triggered an immediate risk-off sentiment in global markets. After all, it was the quantitative easing and near-zero interest rate policies by central banks for over a decade that had fuelled the strongest market rallies in this period. After some early nervousness, investors seem to have taken the prospects of further increases in interest rates and their implications in their stride and get on with business. This confidence stems from expectations that despite decade-high interest rates, the world’s largest economy will not slip into a recession and the US consumer will remain strong.

At home, the Volatility Index or VIX dipped 5.5% last week to 10.84, which is below its average historic range of 12-18, suggesting traders see little risks to the market in the near term. Part of the confidence in the current risk-on market sentiment has come from the revival of foreign portfolio inflows in the past four months after nearly 22 months of net selling till February. In June, foreigners pumped ₹16,400 crore into Indian stocks after investing nearly ₹44,000 in May. The flows are part of the rotation trade in the emerging markets basket where incremental money is moving from China to India and select Latin American markets.

While the Sensex and Nifty closed at all-time highs on Friday, some market participants said the recent moves did not feel like a bull run. That’s partly because the last part of the up move to the record level appeared to be tentative. Also, many of the stock leaders in past market rallies have been relatively sedate this time. According to Motilal Oswal Securities, stocks such as Infosys, TCS, SBI, Adani Enterprises, ICICI Bank and Bajaj Finserv are still below their levels on December 1, 2022 – the previous market peak. ITC, Tata Motors, Bajaj Auto, UltraTech and Nestle are among the 28 stocks on the 50-share Nifty that have been instrumental in the index’s surge since December. But, beneath the world of blue-chip stocks, a stronger record-breaking bull rally has been playing out.

Mid- and small-cap indices, which hit all-time highs on Friday, are up 20% and 23% from their 2023 lows on March 28. In comparison, the Sensex and Nifty are up about 10-11%. While retail investors are pouring money into small- and mid-cap mutual funds as seen in May as against large-cap or flexi-cap schemes, individual traders are aggressively focusing on this space to spot the next winners.

The heightened focus on smaller shares is reflected in their total market value. Motilal Oswal’s study showed Nifty Midcap 100’s market cap is around ₹37.5 lakh crore as against ₹34.4 lakh crore during its previous peak on December 1, 2022 ( Sensex/Nifty peak).

Similarly, Nifty Smallcap 100’s market cap is at around ₹13.7 lakh crore as against ₹10.7 lakh crore in December. In comparison, Nifty’s market cap is at around ₹148.4 lakh crore as against ₹150.5 lakh crore in December. This is an indicator that domestic traders are more focused on specific stock moves than the broader index moves. On Friday, the open interest or outstanding positions in single stock futures hit an all-time high, indicating heightened speculation in various stocks.

As the euphoria in mid- and small-caps continues to build up, it will be important to keep a watch on near-term flows in the near term. The smaller shares have been able to perform mainly because of relative stability in the Sensex and Nifty, driven by foreign flows along with support from the growing pool of local investments.

Signs of a slowdown or a reversal in overseas flows will be a good time for retail traders to turn cautious on smaller shares in the near term. While various market indicators are pointing to complacency creeping in, headline share valuation readings are increasingly offering little comfort. Disregarding Fed’s rate actions have worked well for now, but investors must be wary of abrupt disruptions as a consequence of record-high US rates.