Stockmarket: Bull On The PROWL

Industrial growth has slowed, software stocks appear overheated and old economy stocks have been hammered down to abysmal levels. Then, why do prominent FIIs expect a no-holds-barred bull run from January 2000?

You may not think much of statistics, but Ridham Desai, India Strategist at JM Morgan Stanley, loves them. Perhaps he has no choice, because he has little else to rely on as he tries to make sense of the equity markets. And, even you'd agree that stats are more dependable than the astrologer doing the rounds on Dalal Street, or your friendly-neighbourhood punter.

Here are a few stripped-off-the-heavy-numbers translations of the bar charts, peaks and troughs you're likely to find on Desai's pc. That the five bull runs we've seen over the past 10 years have all been preceded by binges of liquidity. That every time the Bombay Stock Exchange (BSE) Sensex slips to around 11 times its forward earnings, the 30-share index bounces back with a vengeance. That when market ownership-the ratio of market capitalisation to m2 (money that can be spent immediately plus assets invested for the short-term)-touches 50 per cent, markets tend to rally. That two-thirds of your returns from the Indian markets would have accrued in the November-February period if you had bought at the bottom and sold at the peak over the past decade. And that close to 40 per cent of the net investments of foreign institutional investors (FIIs)-that's roughly $4 billion-flow into the Indian markets during the January-March quarter.

Phew! If you still don't get it, well, the JM Morgan Stanley strategist is predicting a rally on the Indian markets-a 25 per cent appreciation in the next four months. He isn't the only one. Fund managers, brokers, and research analysts agree that the nine-month bear market during which the Sensex slipped from a high of 6,150 to a low of under 3,500 is all but over. ''We feel we are close to a bottom,'' says S.N. Rajan, Chief Investment Officer at Kotak Mahindra AMC. ''This view is strengthened by the the resistance being faced by the Sensex at 3,700 levels, and by leading stocks like Infosys, which is facing strong resistance at Rs 7,200 levels.'' (At the time of writing, the Sensex had crossed the 4,000 barrier.) DSP Merrill Lynch's Head of India Research Jyotivardhan Jaipuria feels valuations are looking attractive now, and is counting on at least one of three triggers that will unleash the bull (more of those later). And if it's Sensex predictions you're looking for- few are willing to stick out their necks (''we've had enough of them,'' says Kotak's Rajan)- then perhaps you should try laying your hands on a Credit Lyonnais Securities Asia Report. Via an analysis of fundamentals and technicals, the firm has predicted a mind-boggling 8,500 for the Sensex by mid-2001. That may sound outlandish today but, on the more conservative side, 5,500 is a level that players are confident the index will reach in three-four months.

If you go by last fortnight's northward movement of the Sensex, you'd probably conclude that the rally is well on its way, although most of the buying was concentrated in the beaten-down FMCG and manufacturing sectors. In the week beginning November 27, the index had already gained over 150 points in the first two days to cross the 4,000 mark, on the back of solid FII buying. In fact, through November, FIIs have been net buyers to the tune of almost Rs 1,000 crore, reversing the previous month's trend of an outflow (of Rs 272 crore).

A bull run? You've got to be kidding. How can the market ignore the economic and industrial slowdown that's staring it in the face? Cumulative growth in the five months to August has after all slipped to 5.3 per cent, against 6.3 per cent in the previous year's corresponding period. This dismal showing is manifest in the poor earnings of non-software companies, and the miserable valuations they're receiving. And how can one forget the recent oil price hike, which has resulted in inflation shooting up (to 7.56 per cent for the week ended September 30 from 6.06 per cent the previous week).

A bull run? You need big money for that. Where's that going to come from? Not from foreign investors, for sure-not in a year in which emerging markets have seen outflows. After all, the fears of the US economy slowing down have compelled emerging market investors to turn a blind eye to the higher-risk developing economies. And once Morgan Stanley rejigs its Asia emerging market index, won't India's weightage decrease?

Yes, a bull run. For the moment erase those pictures of gloom from your head and focus on these whole host of factors that marketmen feel will drive up the markets over the next few months. For starters, the liquidity scenario promises to improve thanks largely to the inflows from the State Bank of India's issue of India Millennium Deposits (IMDs). Then, domestic mutual funds too are sitting on a stash of investible cash. The Indian software story-coupled with the fair valuations of some of the outperformers in this sector-should also play its part. And if the government does manage to kickstart reforms and make the index of industrial productivity look better, the beaten-down manufacturing stocks too would add fuel to the rally. Finally, funds might have been ignoring emerging markets for some time now, but valuations are at rock-bottom today-right from the Philippines to Korea-which make these markets attractive bottom-fishing plays.

But what should provide a sure-fire trigger in the days ahead is FII money flowing into the Indian markets over the next few months. It's worked out that way virtually year after year, ever since the pin-striped brigade began investing in Indian equites in 1993. In fact, close to 40 per cent of net FII buying over these years-or close to $4 billion of inflows- has happened during the January-March period. Towards the year-end, the FIIs usually book profits, and come back in the first quarter with a renewed overview of markets.

Indeed, figures of FII investment over the past three years bear this trend out. Consider 1998, for instance, when the foreign investors were net sellers of stock to the tune of Rs 518 crore in October and November. By January, 1999, however, they were buying with gusto, and in the first three months of that year, they pumped in all of Rs 909 crore, almost a fourth of the net inflow in equities for that year.

1999-2000 was no different. In October and November, net sales stood at Rs 1,810 crore. By December itself that trend had reversed, and in the first three months of the new year, the fiis sunk Rs 4,000 crore into the Indian equities market-pretty spectacular considering that just another Rs 2,000 crore was the net inflow till October, 2000.

No one has any definitive reason for this pattern. Some attribute it to fresh allocations that happen at the start of every year, but fund managers who've been there maintain that there's nothing sacrosanct about January, and that allocations are an ongoing process. Others say that the beginning of the year is the generally the period during which retail investors-after receiving year-end bonuses-invest in mutual funds, which in turn divert some of those funds to emerging markets. And yet others say that the early year inflows are related to expectations from the Union budget which, at least in India's case is, more than a balancing-of-books exercise, an opportunity for the government to unfold further reforms.

Whatever the reason, the pattern exists, and you have to really wonder why it shouldn't repeat itself this year, all the bearishness about emerging markets notwithstanding. But it's more than just patterns that we're relying on to herald the bull. Certain domestic factors too augur well for the markets. Like liquidity, which is expected to ease considerably over the next few days. This is of course thanks largely to the inflows expected from the State Bank of India's issue of India Millennium Deposits, which has raked in over $5 billion. Even as it helps neutralise the estimated $3 billion expected outflow because of the hike in crude oil prices, analysts feel that the overhang could go a long way in propping up the markets. That the government has completed over 85 per cent of its borrowing programme should also improve the liquidity scenario. And lest you forget what Desai's charts have plotted, that the past five bull runs have all been triggered by healthy liquidity in the system.

Meanwhile, the domestic mutual funds too are sitting on plenty of cash, having made very little purchases this year. This is because they probably expected heavy redemption pressures, which, well, weren't that heavy. Desai estimates that funds are sitting on $700 million, which is close to 10 per cent of the money invested in equities. ''I would reckon that average cash levels would be under 15 per cent,'' says Kotak's Rajan. ''Domestic liquidity is not a problem, but where is the trigger?'' asks Rajiv Vij of Templeton Asset Management.

That trigger will have to come from the foreigners. As the chief investment officer of a foreign fund points out: ''Domestic mutual funds are usually followers, or fence-sitters, who join the party once it begins. But make no mistake: it's the fiis who lead a rally and give direction to the markets.''

U.R. Bhat, Chief Investment Officer at Chase-Jardine Fleming, feels that it's the Indian tech story that will prompt foreign investors to pump money into the Indian markets. The good news is that investors are realising that the software services-dominated domestic tech sector is completely different from the dot.com and product-heavy Nasdaq. That explains why the Indian markets showed some sanity even as the Nasdaq plunged by almost 50 per cent over the past few months. ''India is not getting as badly burned by the profit warnings of US tech companies. This will allow foreign funds to take a thematic exposure in India. And it's when the disconnect with the Nasdaq is complete, which should happen in a couple of months, that I see big money coming into the Indian markets,'' says Bhat.

Fly In The Ointment # II

A Tale of Two Economies
Forget about the slowdown in the Indian economy for the time being (can you?) and look beyond to the land of plenty. After all, the biggest trigger that could propel the Sensex is foreign-read US-money. But signs of 'economic cooling' are all over the American landscape. The nasdaq has slipped some 45 per cent over the past six months, and the Dow is virtually stagnant. ''If there is a slowdown in the US economy, emerging markets will be the first to go out the window of foreign investors,'' says Rajiv Vij, CEO & Country Head, Templeton Asset Management. What we are witnessing now, add analysts, is a global contraction of capital, what with the US Fed maintaining fairly high interest rates. And as liquidity becomes scarce, investors begin shying away from higher risk-read emerging-markets.

Inflows into mutual funds in the US, meanwhile, are still happening, although they have been slowing down. According to mutual fund tracker Lipper of the US, net fund inflows into equity funds stood at $8 billion in October, roughly half of September's figure, and down a long way from February's record figure of $53.68 billion. Analysts, however, feel that the US Fed will soon have to ease interest rates, perhaps some time early next year. That's when investors will once again start looking for avenues to diversify their investments outside the US. According to mutual fund-tracking body, Investment Company Institute, US mutual funds with an international focus now account for 10 per cent of industry assets. More than 1,100 funds, with assets in excess of $608 billion, invest outside the US. In 1991 that figure stood at just $39 billion. Of course, it's only a fraction of that money that reaches Indian shores ($1.2-1.5 billion annually).

Now let's come back to the slowdown in economic and industrial growth at home, manifesting itself in stocks of manufacturing companies, which are quoting at rock-bottom valuations, thanks to their poor earnings growth. The picture doesn't look too good. Foreign investors won't be enthused by the rising fiscal deficit, stagnation in FDI inflows, half-baked attempts at privatisation (the divestment in banks is being unanimously hailed as a fiasco), and the reluctance to unleash some big-ticket reforms in, say, power or telecom (annoucements are one thing, and action another). ''For real big money to come in, we need a clean break from the past,'' says U.R. Bhat, Chief Investment Officer, Chase-Jardine Fleming.

The good news amidst all this is that India's success story -software-is independent of the Indian economy. Also welcome is the gradual delink of the Indian software services sector from the product development and dot.com heavy Nasdaq. Indeed, the expected rally on the Indian markets will be largely driven by software-at least by those stocks that have surpassed earning forecasts. Bottom-fishing might seem a good idea in the manufacturing sector, but if there's money to be made on the Indian markets in the next few months, it's in tech.

The market, for its part, feels there's still enough steam in the software sector to keep it going. Although the sell-off on the Nasdaq did result in software stocks getting hammered in October, analysts believe that there was little reason for the Indian stocks receiving such treatment. After all, the results of the first-rung players continue to beat analysts' expectations. What's more, the slowdown in the US doesn't seem to be impacting these companies as they've been able to take on more clients. If an Infosys is today quoting at a one-year forward p/e of 50, even as its earnings continue to grow at 70-80 per cent, analysts feel it's worth accumulating at current prices. So what is expected to fuel the rally is the fair valuations of these software outperformers- rather than the entire sector-and their ability to consistently exceed analysts' expectations. And don't forget that software has a 40 per cent weightage in the Sensex.

Will the retail investor join the party this time? You'd probably conclude that the slide from 6,000 to 3,500 would have resulted in a number of small investors burning their fingers, and therefore staying clear of the markets. The problem, of course, is that the retail guy gets in when over half of the rally is over. If he's really unlucky-and that's often the case-he might even get in at the peak. But here too you could rely on the research of Morgan Stanley's Desai to conclude that the faith of retail investors in Indian markets is actually getting stronger. Don't believe us? Check out these figures. Of the $50 billion of savings that households have in financial assets-that's roughly 11 per cent of GDP- equities till a couple of years back were getting only