Whole Lot Of Bull, Really

Sachin Abhyankar is staring at a painting of bulls flying way above the grey landscape as he tries to explain how the Sensex, zooming up like never before, had belied all his earlier expectations. Abhyankar, vice-president (research), Motilal Oswal Securities, says he had thought the earlier rally this year would take the BSE index above the 8500 level. Once the Sensex crossed that target and zoomed to 8800 in September, he, like many others, started looking for the inevitable market correction. The correction came in due course and the index slid to below 7800. But then, while everyone was relaxing and looking the other way, the Sensex bounced back and crossed its earlier high in November. In fact, it even crossed the psychological barrier of 9000 before sliding a bit.

"If you had told me in October that the Sensex would reach 9000 in November, I would have said no way," says Andrew Holland, executive vice-president (research), DSP Merrill Lynch. After investing over Rs 35,000 crore in the Indian bourses in the first nine months of this calendar year, foreign institutional investors (FIIs) were beginning to express concerns. In September this year, foreign brokerages like Merrill Lynch, JP Morgan and clsa were saying that the Indian market was one of the most expensive ones in the emerging markets universe and that it was overvalued, with stocks trading at as much as 18 times their earnings. A Merrill Lynch report at that time added that "there has been a notable drop in sentiment toward India. Investors are now essentially neutral towards India." Sure enough, foreigners pulled out Rs 3,746 crore in October.

But the Sensex, much like the flying bulls in the painting in Abhyankar's office, was on its way up again in November. This second rally witnessed an increase of over 1000 points in just 13 trading sessions, indicating the mad buying spree of the investors. However, there are many qualitative differences between the two rallies. Until September, the bull run had encompassed the small- and mid-cap stocks along with the bluechips and the large-caps. But this time, high volumes have been witnessed only in the large-caps and the frontline mid-cap stocks.

It is evident that there's been a churn in the mid-cap portfolios of different categories of investors. "While the story has not changed for good quality mid-cap stocks, the others have fallen by the wayside," says S. Narayan, managing director, Kotak Securities. Shaheena Mukadam, head (research), IDBI Capital Services, sees a change: "We are seeing new ideas and new stocks that are now attracting investors in the mid-cap segment. I keep hearing of newer mid-cap stocks where people have put in their money and which are doing well."

Others agree that since November, good money has been chasing good stocks. "Money is now coming in to buy better stocks," says Holland. Going by the demand-supply gap, the November rally required lower inflows. The earlier run (until September) had required $1.5 billion; in comparison, the November rally sucked in a mere $800 million. What aided the second comeback of the Sensex was the money invested by domestic investors. Domestic mutual funds, which are sitting on unprecedented collections, invested as much as Rs 3,019 crore in October, even while FIIs were pulling out and the Sensex was falling. In November, while the domestic funds continued to buy, the FIIs too put in nearly as much money as they had pulled out in October.

So, why are investors still pumping in money despite several apprehensions, both about the market in terms of overvaluation and about certain macro-economic indicators like current account deficit and inflation?

While the Sensex was in the correction phase in October, the biggest fear among FIIs was that Indian stocks were among the most overvalued ones in emerging markets. For example, the MSCI Emerging Market index is up 25 per cent this year, but the India index is up 30.5 per cent. But even after research reports underscored this discrepancy, inflows returned to the Indian bourses in November. Market analysts say this is due to the new foreign entrants who believe in the India story. The new set of investors are looking at long-term investment opportunities, and are interested in whether the future macro-economic indicators suggest strong growth prospects. "If you ask me from a short-term perspective, some stocks might be overvalued. But if you ask me vis-a-vis estimated corporate earnings in FY 2006-07 and FY 2007-08, they seem to be at fair values," says IDBI's Mukadam.

The flip side of this argument is that the FIIs who had entered the Indian markets a few years ago are now selling to the newer FIIs. It's a win-win situation as the former are able to book their profits, and the newcomers are able to buy bluechip stocks and aren't forced to seek mid-caps or not-so-hot ones. Also, such cosy deals don't result in a selling pressure; normally, the sale of a large chunk of a particular stock can depress its market price.

In September, most FIIs and other high net-worth investors also thought the market was rising too fast and, hence, was overheated. In addition, they felt that a peak had been reached. "But such peaks are only milestones in our minds and those of the media," says Aunali Rupani, a Mumbai-based stockbroker. Another one adds, "There are no clearcut signs to say that the peak has been reached. You can never say 'this is it'. So, we thought it had been reached at at 7000, then felt it would be 8000 and now think of it as 9000."

Some concerns that the analysts had in September and October never came into play as forcefully as expected. Their worries were about the rising interest rates in the US that would have forced the FIIs to shift their funds from emerging markets back home, high oil prices that actually fell by nearly $10 per barrel, and about the sustainability of inflows to emerging markets, including India, which has continued unabated after a reversal in October. "New investors are attracted by strong corporate and economic growth in India. The Q1 GDP growth will only accentuate this sentiment. Investors always want to be in a market where there is a predictability of growth," says Abhyankar.

After the near-completion of such an eventful year, what should one expect from the next year? A major factor will be foreign inflows. "This was a record year for inflows in emerging markets. That is how India got its allocation," says Kotak Securities' Narayan. Apart from India, it resulted in record highs in the Brazilian and Mexican markets. But most fund managers are predicting lower inflows next year. Yet another hike in US interest rates may lead to a tightening of liquidity. As Indian valuations are still among the most expensive, several brokerages have recently downgraded India. Experts are also predicting a global economic slowdown in 2006, which, too, may affect inflows to emerging markets. So, there will have to be more good news in other areas for the India story to unfold positively.

In the short term, analysts expect a lot of volatility in India. But, over the long term, the sentiments may still remain buoyant. A Hong Kong-based fund manager recently told a newspaper that "there's life in the Indian market." Going by the events in the recent past, the Indian market does seem to have a life of its own. And the Sensex has rocketed to new highs despite several concerns and apprehensions. As one Delhi-based fund manager concludes: "This market is in uncharted territory. No one is sure about the future."