Why is the Indian Market Lagging Behind Global Peers?

Nifty - 1 Year

During all this time, the US market has soared.

This has resulted in a period of huge underperformance for Indian investors.

Just look at the one year chart of the US Dow Jones index and compare it to the chart of the Nifty above. The divergence is clear.

Dow Jones - 1 Year

Reason for the Underperformance: FII Selling

Historically, FIIs have been a driving force behind the rise of the Indian market. Whenever Indian stocks crashed or rose sharply, FIIs were usually behind it.

But that is not necessarily the case anymore. The Indian retail investor has made his presence felt. Via direct investments and mutual funds, retail investors have significantly reduced the influence of FIIs.

But that doesn't mean they have lost their influence. When they buy or sell in large quantities, the market cannot move in the opposite direction until they are done.

This is what we have seen in the Indian stock market since the Nifty peaked back in September 2024. FIIs have been dumping Indian stocks in a relentless manner since.

FIIs are well-known drivers of specific stocks as well as the entire market to an extent. Their dominance over the benchmark indices has reduced significantly over the last few years due to the rise of the Indian retail investor.

But they still hold sway over the stocks in which they have big shareholdings. If they sell continuously, for many quarters, these stocks are likely to languish.

Investors should keep this in mind when considering stocks with high FII holding.

Why FIIs are Selling Indian Stocks

To understand the underperformance of the Indian stock market, it's important to understand the reasons behind the FII selling pressure.

There are 2 main reasons...

#1 Absence of the 'Risk On' Trade

Foreign investors talk of 'risk on' and 'risk off.' These words have specific meanings.

Risk on refers to the flow of money to risky assets, as perceived by FIIs. These are emerging markets, commodities, small-cap stocks in developed markets, etc.

Risk off refers to the flow of money to safe assets, as perceived by FIIs. These are US treasuries, gold, bonds, bluechip stocks in developed markets, etc.

Currently, the Indian markets are in a 'risk off' situation. FIIs prefer the perceived safety of the US financial markets over Indian stocks.

This is mainly due to the war in the Middle East but FIIs were selling long before the war.

Slowing GDP growth and weak corporate earnings as well as the uncertainty caused by the Trump administration's tariff policies were the reasons for the same.

This is a temporary phase. Risk on and risk off always follow each other in succession. Thus, it won't be long before FIIs switch to their aggressive ways.

Indian investors need to just wait out this period of volatility by positioning themselves in fundamentally strong stocks. When FIIs return, as they surely will, these stocks will go up the most.

#2 Buy China Sell India

For a long time, Indian stocks were trading at a premium to stocks in other emerging markets. This was because of India's high GDP growth rate and corporate India's rapid earnings growth.

However, the slowdown in the economy, as well as the poor corporate earnings growth numbers over the last few quarters, have prompted FIIs to look elsewhere.

And China has been the top investment destination for foreign investors.

As per media reports, since October 2024, India's market cap has fallen by about US$ 1 trillion (tn), while China's has risen by US$ 2 tn. This has been called the Buy China Sell India trade.

After many years, the Chinese stock market is showing signs of life. Back in September 2024, China announced an economic stimulus package. This helped to boost FII sentiment.

Take Advantage of Nature of the Stock Market

So, what should you, the investor, do in such a market?

If you watch stock screens every day, the market starts to resemble a rollercoaster.

But the market is not a rollercoaster.

A good way to understand the market is with the analogy that was first used by Benjamin Graham, the father of value investing. He described the stock market as a voting machine in the short term and a weighing machine over the long term.

This means that the volatility you are seeing now is the voting machine at work. Prices are reacting to the buying and selling decisions taken based on the emotions of investors.

What you don't see is the weighing machine quietly working in the background.

This is the smart money buying high-quality stocks at discounted prices. You don't hear too much about mutual funds buying what FIIs are selling even though this has been going on for a long time.

You don't hear the media reporting on how corporate India is preparing for future growth when the ongoing energy crisis ends.

But the weighing machine will have its say in the end.

So pay attention to the fundamentals. Look at how companies are trying to protect margins, find new growth avenues, improve internal efficiencies, and innovate.

Crisis always brings with it opportunities. It's just a matter of taking advantage of them.

Conclusion

No matter what anyone says, there is no way to predict the stock market. If there was, then everyone would have jumped on it and that strategy would stop working.

The stock market is a complex, dynamic system, driven by human emotion. It's not a simple product of our natural world that can be explained by science.

Hence, the impossibility of making correct predictions.

This is why, we at Equitymaster, don't bother with predictions. Instead, we focus on company fundamentals and stock valuations.

That has worked well for us and should work well for you too as long as you apply good investing principles in a disciplined manner.

In the current context do the following:

• Hold only fundamentally strong stocks.
• Sell any stocks that you are not comfortable with for reasons like growth prospects, margin pressure, debt levels, promoter activity, corporate governance, or sectoral weakness.
• Buy stocks that have sufficient margin of safety due to a decline in price and improving fundamentals (both are important).
• Keep enough cash and your watchlist ready.

Instead of worrying about the underperformance of the Indian stock market, stick to proven investing principles and have a long term focus. You will do very well with your investments.

Happy investing.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...