Nifty rallies 25% - Bargains or sheer bravery?

A return of 25% on the Nifty in a little over a month does not happen very often.

April 30, 2020 10:18 IST | India Infoline News Service
In the melee of the COVID-19 pandemic, what investors did not really notice was that the Nifty has rallied 25% from the lows of March 2020. A return of 25% on the Nifty in a little over a month does not happen very often. Check the chart below.

Data Source: NSE

One can argue that the Nifty is still almost 25% below the peaks of February, but that is off the point. The real question is whether there is a method behind this sharp rally over the last one month, or is it just pure optimism? Does it reflect bargain hunting by investors or sheer bravado shown by investors?

Rush to cover short positions

Stock markets have a strange ability to feed on itself. When the markets fell 37% between February and March this year, short positions got built up in sectors like banks, financials and automobiles. However, the government has shown a tremendous appetite to take problems head-on. The 75 bps cut in repo rates, the special TLTRO windows for liquidity and flexibility offered to individuals and businesses have surely made the bears jittery. That explains why the short covering has been so intense in the last few weeks. Also the sharp turnaround in companies in the FMCG and pharma sector has underlined the fact that Indian companies may be best poised to capitalize on the crisis.

FPI selling has tapered in April 2020

After the rapid selling by FPIs to the tune of Rs115,000cr in March 2020, FPIs continued to be net sellers in April. But, the net seliing in April has been a little over Rs13,500cr. That almost makes April look like puppy romance compared to March. The fall in FPI selling has also given confidence to the bulls as they believe that the narrowing valuation premium over the rest of Asia should work in favour of Indian stocks. Also, expensive stocks in the private banking space have almost moved from 40X P/E to 20X P/E. FPIs are also awaiting the MSCI EM rejig in June which is expected to trigger inflows of $3 billion into India. All these are working in favour of bullish sentiments. Short covering is just the support.

COVID-19 is history; it is now about the recovery

Markets have an amazing tendency to factor the future with unerring precision. Markets were prophetically correct about the extent of damage that COVID-19 would cause. But, COVID-19 has done its share of damage and hopefully, the lockdowns should wind down over the next few weeks. That would mean two things. Firstly, economic activity will gradually get back to normal and that would mean revival in supply chains and demand. Secondly, it also means that the monetary and fiscal stimulus provided by the government in the last 2 months will begin to bear fruit. In 2020 and 2021, India and China will be the only two large economies to show positive growth. Most of the developed world including the US, EU and Japan are likely to see economic contraction in 2020 and in 2021. That once again positions Indian economy in a sweet spot and more flows could gravitate to India.

The 25% rally – bargains or bravery?

That brings us to the all important question; is the recent 25% rally in the Nifty bargain hunting or just a show of investor bravery. To an extent it is a mix of both. Let us first understand why this is a lot of bravery. The 25% rally has happened where there still lack of clarity on the lifting of lockdowns. Most of the affected nations are still seeing COVID-19 cases aggravating by the day. Even in India, state governments have been extremely sceptical about lifting the lockdown. That means; normal economic activity is still some time away. Secondly, VIX (volatility index) has fallen from the elevated levels of 85, but at 38-40, VIX is still too high for markets to bottom out. Normally, sharp market corrections exhibit a “C” shaped recovery after the VIX settles below the 20 levels.

However, there is an element of bargain hunting too. Even after the sharp rally in pharma stocks, it is just back to the levels of 2019. That still represents a 60% correction from the 2015 price levels. Then there are the market leaders like HDFC Bank and Bajaj Finance, which are suddenly available at salivating valuations. Unless these companies report structural damage to earnings, investors feel comfortable buying these stocks. But buying stocks after a 25% rally can be tricky. It means; you need to get your shopping baskets out but keep your calculators ready too!

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