A 'double whammy' of Modi's announcement of demonetisation of Rs 500 and Rs 1000 bank notes and Trump's unexpected victory in the US Presidential elections created major panic in the market.
Those were triggers for increased selling by FIIs. Here are 5 reasons why they may continue to sell Indian equities for some more time:
1. FIIs were net sellers of Indian equity worth Rs 57.7 Billion during Oct '16 as Nifty's TTM P/E was in a range between 22.98 and 23.80 - well above its average valuation.
During Nov '16, Nifty's TTM P/E range has been slightly lower so far - between 21.19 and 23.31 - but still well above its average valuation.
2. US bond yields have moved up above 2.3%, and are expected to move up further to 2.6% or so. Why? Because of rising inflation expectations on prospects of Trump's pro-growth policies.
FIIs prefer the safety of US bonds to riskier emerging market equities.
3. US Fed is likely to increase interest rates at its policy meeting in Dec '16. At least two more interest rate increases are expected during 2017.
Since rising interest rates usually lead to lower bond prices, yields will get a further boost which can cause more FII outflows.
4. China's economy is slowing down, which has triggered a slump in commodity prices because China is one of the biggest buyers of commodities. Since commodity prices and the US Dollar trend in opposite directions, the Dollar has been strengthening.
A strong Dollar usually leads to selling in all emerging markets. Currencies of Indonesia, Phillipines, Mexico, South Africa, Turkey have depreciated much more than the Indian Rupee.
5. As per nominal interest rate parity theory, lower interest rates lead to a stronger currency and higher interest rates lead to a weaker currency. This is a major reason why the Indian Rupee has been depreciating against the US Dollar for quite some time.
The recent FII selling in the Indian stock market has further depreciated the Rupee against the Dollar.
In a recent interview on a business TV channel, the global equity strategist of Citi Group said unequivocally: FIIs look at three things - US Dollar, US Treasury yield and China.
Rising US Dollar and rising US Treasury yields means selling in emerging market equities (and vice versa - i.e. falling Dollar and falling yields trigger buying in emerging market equities).
A likely Trump policy against outsourcing of US manufacturing will further affect economic growth in export-oriented nations like China, Taiwan, South Korea, Malaysia.
A self-contained economy like India will be less affected by such a policy. So far, Trump has mentioned about restricting H1B and L1 visas but nothing against services outsourcing.
Demonetisation of bank notes has led to shorter-term ETF money outflows. Longer-term long-only funds may wait for Q3 and Q4 results of India Inc. before taking a call.
If the short-term damage to India's GDP growth is not 2% (as Dr Manmohan Singh mentioned in the Rajya Sabha) but 0.5% (as Mark Mobius of Templeton said in a TV interview), Indian economy should recover over the next 6 months.