Will markets be able to shake off the blues?

Where are Indian equities headed in the short term? Going by the severity of Friday’s fall and the continued weakness in global markets, chances of a recovery appear slim. The Dow Jones Industrial Average fell by 208 points, or 1.5%, on Friday to close at 13,265.47, while the Nasdaq Composite Index shed 37 points, or 1.4%, to end the day at 2,562.24.

Back home, the futures segment on the National Stock Exchange could hold some clues about the short-term trend. On Friday, foreign institutional investors were net sellers of Rs 4,985 crore ($1.24 billion) of Nifty August futures, which closed at 4,402.20, a discount of nearly 43 points to the spot. Dealers said the quantum of sales was unusually large, even after accepting the fact that the derivative market is much more liquid than it was about a year ago.

Market players haven’t a clue as to who could have absorbed this huge chunk of sales. While FIIs account for roughly 38% of the outstanding positions in the market, derivative traders say the top five players among them account for nearly 70% of the market share. Individual investors are unlikely to have been the major buyers.

For one, most of them have been long on the market and would have been trying to unwind their positions rather than building fresh ones. Also, brokers would have been cautious in allowing them to take up long positions in a falling market. Many of the key market operators too are reported to have taken a bearish view for the time being and are unlikely to buy in a big way.

As the figures speak for themselves, foreign funds have been net sellers. While activities by domestic mutual funds have been on the rise, they too are unlikely to have gone long on the Nifty, given the fragile sentiment in world markets.

“Nifty futures were being unloaded (by foreign funds) at a 40-50 point discount to the spot; a clear indication of panic selling, and it needed real guts for somebody to stand up to them,” said a derivatives trader. So who absorbed the avalanche of Nifty futures unloaded by foreign funds on Friday?

Market watchers say a cartel of highly influential domestic investors were behind the purchases. This group is betting there is likely to be a short-term rebound which will allow them to exit their positions at a neat profit. Over the past couple of weeks, Indian indices had managed to gain ground despite the correction in world markets.

Strong foreign fund flows apart, this cartel too is said to have contributed significantly to the trend. Still, some of the seasoned players say the cartel’s act of taking up huge long positions in the market is no assurance of a recovery in the short-term. After all, these players had taken up huge long positions in Nifty futures in February just ahead of the Budget in a falling market. Despite the purchases, the market continued to fall over the next couple of weeks.

Coming back to present correction, foreign fund flows will be a deciding factor for a near-term recovery. And the global liquidity scenario does not look too promising at the moment. Apart from the crisis in the sub-prime loan segment, markets’ reluctance to finance a couple of high-profile leveraged buyouts (Chrysler in the US and Boots in the UK) has required banks to step in and subscribe to these offerings.

In effect, that could mean cash, which could have found its way to risky assets such as emerging market equities, will no longer be available. In addition, the emerging sub-prime losses would require many banks and hedge funds to liquidate their positions elsewhere and shore up their capital at home.