A bounce is building in the market, but will it last?

However, market participants warned that a short covering-led rally could prompt investors singed by the recent correction to cut losses, potentially limiting the life of the rebound. For now, they don't expect any significant impact from the indictment of Gautam Adani and other top group officials in the US, over allegations that the conglomerate has termed baseless.

"The market retracement will continue after the spectacular victory of the BJP-led alliance in Maharashtra," said Madhusudan Kela, founder of MK Ventures, a financial services firm, adding the recent correction has presented buying opportunities in beaten-down quality PSU stocks in capital goods, defence and railways.

The Nifty and Sensex gained around 2.5% each on Friday as foreign Investors covered part of their bearish bets ahead of the state's election outcome over the weekend. To be sure, the market was near heavily oversold zone, indicating that a bounce was overdue.

The bellwether Nifty alone had corrected 11.5% or over 3,000 points from its record high of 26277.35 on 27 September through Thursday's low of 23263.15. A fall of 10-20% from the peak is termed a correction and more than 20% signals the start of a bear market.

The recent fall was led by net foreign investor selling of ₹1.2 trillion worth of shares since October. While domestic institutions led by mutual funds pumped in a net ₹1.45 trillion to counter them, their purchases failed to absorb the flood of shares from companies going public, as well as private equity funds selling shares. For instance, two large IPOs alone--Hyundai Motor India Ltd and Swiggy Ltd--totalled supply of ₹39,198 crore worth of shares over this period, neutralizing the effect of domestic institutional buying.

The market correction took root following poor quarterly earnings and the uncertainty over the US election outcome, bringing the Nifty down to one-year forward price-earnings multiple of 19.6 times. This compares to 20.55 when the market hit a record high on 27 September, and the two-year average of 19.3.

Aside from selling ₹1.2 trillion worth of shares since 1 October, FIIs were cumulative net short Nifty and Bank Nifty index futures by 154,349 contracts on Friday. This leaves scope for "further short covering," said Ambareesh Baliga, an independent market analyst.

Also read | Record FII exodus shakes India’s stock markets even as domestic funds step up

"The sweep in the state elections of Maharashtra was more than a narrow victory that majority pollsters forecast, and markets are likely going to give a thumbs-up to that on Monday," Baliga said.

While Chanakya had forecast 152-160 seats for Mahayuti, the BJP-led alliance, it won 230 of 288 assembly seats.

Baliga added that the rise, though sharp, could be sold into as most investors stuck at various levels of the 3014 point fall in Nifty from 27 September to date would exit their positions at a smaller loss or slight profit.

"These are largely investors who haven't seen a fall in the past two to three years and will sell the rise," he explained.

Before this, though, the short-covering by FIIs could result in stock futures rising and thus spur buying in cash by arbitrage funds which exploit spot-futures price differential to earn risk-free gains - buying in cash and selling futures to capture the spread at futures contract expiry when spot and futures prices converge.

A rebound is also likely to be supported by global index provider MSCI rebalancing its Emerging Market index on Monday. According to Nuvama Wealth, the rebalancing will lead to foreign passive inflows of an estimated $2.5 billion into India, with around $1.9 bn of it into HDFC Bank alone, whose index weightwillrise.

Neither Kela nor Baliga expect the Adani group's latest troubles to hurt markets as of now, with the former expecting the group's "resilience" to enable it to tide over the "current storm."

Baliga, however, expects the US court indictment to have a "negative overhang" on group stocks until clarity emerges on the legal case.

Short-covering

While FIIs sold a provisional ₹1278.37 crore worth of shares on Friday, they covered 46,712 index futures shorts, buying them back for ₹3018 crore on Friday, exchange data showed. This brought their cumulative net shorts down to 154,349. Apart from FIIs, net shorts were held as hedges by DIIs (25,525 contracts) and proprietary traders (58,011 contracts). The counterparty to these investors were retail/HNI designated client by NSE, who were net long 237,885 contracts as of Friday, per NSE data.

"The bounce we saw on Friday could continue till the Nifty retraces 50% of the fall from the September 27 high to Thursday's low," according to Rohit Srivastava, founder, IndiaCharts.

A 50% retracement of the fall from 26277.35 to 23263.15 lies at 24770, 863 points or 3.6% above Friday's closing of 23907.25.

Also read | Adani indictment rocks equities and bonds alike

Apart from futures, the market-wise put call ratio (PCR) stood at 0.73 on Friday , which means for every 100 index and stock option calls sold, only 73 stock and index puts were sold, keeping the market near the oversold territory. The bounce is predicated on those short or bearish call options contracts closing them out, which will increase the PCR.

According to Srivastava, the last two-year range of PCR is 0.7-1.04, with a reading below 0.7 indicating heavily oversold condition and that above 1.04 signalling overbought markets.