Bottomline: Foreign flows don’t steer the market

There is a difference between perception and reality. It is logical to assume foreign fund inflows help drive up stock prices and vice-versa. And that is true to an extent, but if you think you can tell where the market is going to go based on how foreign funds are behaving in the cash market, you’ve got a very tough task at hand. Let’s say, near impossible. Here’s why.

March 2022 was a month in which foreign investors net sold shares worth Rs 43,281 crore. In the same month, the NSE-50 Index (Nifty) moved from near 16,800 to over 17,400, a gain of near 4 percent in a month. Similarly, in December 2021, while the net foreign investor withdrawal was about Rs 13,500 crore, the Nifty ended with gains of 2.2 percent.

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But this is just anecdotal evidence of divergence. A more studied approach reveals that since 2007, the correlation between net foreign money flows and Nifty change is just about a moderate 0.5 percent. And that’s not a strong enough linkage to use as a basis for forecasting market direction.

The chart above shows that while the markets have been choppy in the recent past, there hasn’t been a secular decline despite a clear trend of foreign fund outflows.

A much better gauge of where the Nifty may be headed is the US market. A look at the Standard & Poor’s 500 stock index (S&P-500) reveals a strong synchronization with the Nifty. And that isn’t surprising. Like Uday Kotak recently tweeted, “When US sneezes, the world catches a cold”, so do Indian markets swing to the US market tunes.

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A similar quick study since 2007 to assess the correlation of the Nifty to the S&P-500 reveals a result of 0.98, which is almost as good as it ever gets. It suggests a near 1:1 move in the Nifty in-line with the S&P-500. Hence, a better gauge of where the Indian market is headed would emanate from US equities.

So, where could we be headed?

The S&P-500 saw a sharp slide on Friday with the index ending near 117 points lower, down 2.9 percent. That is delicately close to a previous closing low, also at near 3900. After this fall, the S&P-500 is down 19 percent from its high and very close to entering bear territory (a 20 percent decline or more). If that happens, the earlier low of 3810 is a distinct possibility and a further decline could even see the index slip to near 3500, which would spell an over 27 percent decline. A similar decline in the Nifty could take it closer to 13600.

But remember there are lots of ifs and buts here. It isn’t easy to forecast market moves, and least of all do it accurately or consistently. So, investors should stick to a disciplined approach of either investing in index SIPs or, if they have the time and capacity, by buying promising businesses at attractive valuations and not worrying too much about market swings.

Happy investing!