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Markets in the process of forming an Intermediate low. Most resilient stocks collapse in last leg of sell-off

In this note we highlight the reasons why market could be in the process of making an intermediate/temporary low. Our long-term models are still retreating from the big euphoria zone (of 2006/2010/2018) hence we believe the bigger trend, largely for Mid and Small caps, is down. But excess short crowding and margin led sell-off etc. have created strong relief rallies in the past which have lasted for a few weeks to months (ranging from 7%-12%). We feel markets could have entered that zone now:-

* Unwind in margin funding book created the latest sell-off: We have seen a sharp reduction in margin funding book in the month of Jan and Feb. In Jan’25, margin funding book was down by INR 5,000 crores and in Feb’25, it fell further by INR 6,600 crores. This is the sharpest fall since the rally which began post COVID.

* Strongest & most resilient stocks collapse towards the last leg of sell-off:

One marker for a bottom is that the strongest and most resilient names collapse in the final leg of sell-off. In the current cycle- IT, FMCG, M&M etc. were resilient to the selling which started in Oct’24. However, since mid-Feb’25 we have seen a sharp collapse across most of these names. Large shorts have also been created in many of these stocks as participants panic and start shorting names which haven’t seen damage.

* Implied volatility has remained subdued in the latest round of sell-off from Feb’25 onwards: The implied volatility has barely risen in the last round of sell-off since Feb’25. This is a good leading indicator of markets expectation of the correction halting soon. In past, a fall in markets without a subsequent spike in Implied Volatility was many times visible ahead of an intermediate bottom formation.

* Most indices reach the lows made on election day result: The low made by market on 4 th Jun was nearly pricing the loss of Modi government at one point of time. However, the results turned around and markets went into an upswing again, drawing the last of sideliners inside. Delivery volumes on that day had spiked closer to record high. This should act as one strong reference point for players who would want to increase equity allocation. Also, any slowdown in supply in this zone can push prices higher.

* Most indices reach 100 week moving average zone: Markets have always taken one round of support around its 100-week moving average zone in past. In almost all instances since 2004, we have either seen an interim low or a final low marked in this zone. In Mar’08/Mar’11/Jul’18 period, we saw an interim relief rally between 10%-20% before breaching the lows a few months later. In Apr’03/Aug’06/Feb’16/Jan’17/Jun’22/Apr’23 period, we saw markets making a final low in this zone. Our view is that we could see a healthy round of bounce before these levels again get breached later.

* Dollar unwind trade already halted across all EMs except India: The sell-off across EMs since Oct’24 (post Trump victory) was a topdown trade as money was moving back to the US. This has already halted across all large EMs since the past 2/3 weeks. India flows are still weak, but we could see that pressure also coming down in the following weeks.

Spike in Advance-Decline ratio has potential to trigger bigger covering rally. Global Risk appetite still intact

* Stocks hitting 52-week low spike to 30%: Around 30% of NSE500 stocks have already hit their 52-week low; zone where one bottom has formed in past.

* Global Risk Appetite is still intact: Our “Global Liquidity Tracker” shows that the global risk-on environment is still not challenged. In past, Indian markets have not seen one sided correction if Global markets are strong/supportive.

* Advance-Decline ratio for all NSE stocks spike to 6x: The breadth expansion on NSE yesterday is sharpest since Apr’24. Such strong breadth recovery after markets hitting lows is a strong trigger for larger short covering and cash deployment by funds. In most corrective phases of markets, a spike in A/D ratio above 5x has triggered a strong follow-on recovery.

* Extent of recovery: Generally, bear market rallies happen to retrace 38% to 50% of the total fall. This would correspond to 6%-10% of further rally from here in Midcap Index & 5%-8% rally in Nifty. In a few instances, we have even seen a 61% retracement of the fall before resuming the next down leg.

* What to focus? : After the initial broad-based rally, we could see focus shifting to just the top-100 to 150 stocks. Hence, we would advise to play the move only through large cap names (within top 100-150 stocks). We have also highlighted the list of stocks where largest shorts have got created since start of this year & hence could be potential covering targets.

Margin book unwinding created pressure since Jan’25; Short interest spike to Aug’21/Jun’22/Mar’23 highs

The broker margin funding book has grown more than 3x since Mar’23 from INR 26,000 crores to INR 82,000 crores by Dec’24. However, since the start of this calendar year, we are seeing unwinding in that book which is creating a big pressure on the market.

In the month Jan’25, margin funding book was down by INR 5,000 crores and in Feb’25, it further fell by INR 6,600 crores. This is the sharpest fall since the rally which began post COVID. Generally, we have seen such unwind being associated with forced selling and have coincided with short term bottom in market.

Source: EPFR, Elara Securities, Research, Bloomberg, Capital Line, ACE MF

In the month Jan’25, margin funding book was down by INR 5,000 crores and in Feb’25, it further fell by INR 6,600 crores. This is the sharpest fall since the rally which began post COVID. Generally, we have seen such unwind being associated with forced selling and have coincided with short term bottom in market.

Generally, short covering brings the first leg of rally in markets after which we see buying emerging in select pockets and momentum players jump in.

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