Mumbai: Indian fund managers are sitting on less money than they have at any point in time in the past 20 months—an indication that they have invested heavily in stocks and, to a lesser extent, that the market may be close to peaking.
Cash holdings of diversified equity funds averaged 5-6% of total assets in September, according to data compiled by mutual funds tracker, Morningstar India. These levels were last seen during December 2007 and January 2008, when the markets were at their peaks.
With stock valuations well above historical averages, more fresh equity issues waiting in the wings (thereby sucking money from the system), and economic recovery in the Western world not stabilizing, voices calling a correction in the market rally and predicting a so-called double dip, or W-shaped recovery, are growing louder.
Also See Liquidity Crunch (Graphics)
Billionaire investor Rakesh Jhunjhunwala talked about this two weeks ago at a private equity conference. And two recent reports from international research houses, too, have raised concerns about this liquidity-led rally.
“This could possibly be one indicator, but it shouldn’t be read alone” said V. Anantha Nageswaran, chief investment officer of wealth management firm Julius Baer Group in Singapore, referring to the decline in cash holdings. Due to government stimulus and a policy of easy liquidity, “money is chasing all kinds of risky assets. Markets have overshot fair valuations,” added Anantha Nageswaran, who is also a Mint columnist.
After toxic debt choked credit and global markets last year, governments and central banks across the world moved to an easy money policy. Some part of the liquidity that subsequently flooded the system found its way to emerging market equities. Globally, fund flows to emerging markets have exceeded the inflows of 2007. In India, foreign institutional investors have pumped in $14.24 billion (Rs66,074 crore) since January after pulling out $12.18 billion last year.
The Sensex, India’s most tracked index, climbed at least 108% since the lows of March, a rate of growth surpassed only during its rise in the early 1990s during a stock market scam engineered by the late trader Harshad Mehta. The index is trading at 20.96 times the estimated earnings for fiscal 2010. The average range of valuation for the index has traditionally been 14-17 times earnings.
A large part of the rally has been fuelled by institutional investors—both foreign and domestic.
A recent Bank of America-Merrill Lynch report said that there could be an imminent correction of up to 10% ahead of a second rally. Similarly, a 20 October report from the research arm of Australian Bank the Macquarie Group noted that “based on valuations alone, the risk/reward trade-off for Asian equities is poor”. According to this report, there is a greater than 60% chance that markets will be lower in three months’ time “if history is a guide”.
To be sure, the conditions between December 2007 and now are different in some ways, as Nilesh Shah, deputy managing director of ICICI Prudential Asset Management Co. Ltd, which manages Rs80,000 crore worth of assets, pointed out.
“Investor behaviour is different now,” Shah said. “In the last quarter of 2007, we were seeing large inflows. That’s not the case now.”
Indeed, equity funds saw net outflows of Rs1,756 crore in September, which is just over 1% of the Rs1.7 trillion of assets under management in that category. India’s 36-firm mutual fund industry had Rs7.4 trillion assets under management in September. A larger portion of money is routed into the market through insurance plans called Ulips.
“These low cash levels reflect the optimism of fund managers. It has gone up in the past six months,” said Ved Prakash Chaturvedi, CEO of Tata Asset Management Ltd, which manages Rs20,200 crore worth of assets. “But independent of cash levels, there’s an expectation of a correction. When and how it will happen, it is difficult to predict.”
Bank of America-Merrill Lynch’s Jyotivardhan Jaipuria and Anand Kumar listed some of the reasons why a correction is on the cards.
In a 15 October report, they noted that while “earnings will beat estimates, market expectations are running much higher. We expect markets to sell on good news”.
The pace of analyst upgrades is starting to slow, which could be negative for markets, they said.
Besides, the large number of fresh issues through initial public offerings (IPOs) and other instruments will suck up liquidity. IPOs and qualified institutional placements, when firms offer shares only to institutions, have mopped up some Rs34,200 crore till September. Merrill estimates this number to increase by $10 billion in the next six months.
Analysts are also worried by a withdrawal of the government’s fiscal stimulus packages worth 3% of India’s gross domestic product that were announced late last fiscal year and which are responsible for some part of India’s sharp recovery.
Local brokerage Enam Securities Pvt. Ltd listed “roll-back of excise and service tax reduction” as a risk factor.
Another worrying factor is the slow recovery in the developed world. India is dependent on capital inflows—both portfolio and direct investment. A weak US and Europe would mean no demand for exports, already under pressure from an appreciating rupee. The local currency has appreciated 8.27% against the dollar in the current fiscal year. A strong local currency brings down the value of dollar earnings of exporters in rupee term.
Ashwin Ramarathinam contributed to this story.
Graphics by Yogesh Kumar / Mint