December 2012

From December 12, 2011 to date it’s been a rewarding year for equity investors who have remained patient. The broader indices have delivered double digit returns during this time with most of the high quality businesses delivering returns in excess of 25%. FII’s were net buyers to the extent of 1 Lac crore plus whereas domestic investors were net sellers and clearly showed lack of faith in the Indian equity market. As we speak we are just 7% away from a new high in NIFTY. The markets have also consolidated in the last few years where most of the weak hands have now been replaced by stronger ones.

Since the high of January 2008, FII’s have invested close to 2.75 Lac crores whereas MF’s have been net negative to the extent of 34000 crores. We have also seen sector rotation where high cash flow generating businesses have made new highs while leveraged businesses have touched new lows. As on January 2008 Reliance Industries and ITC were valued at 4.57 Lac crores and 73000 crores respectively. The same in today’s date stands at 2.66 Lac crores and 2.36 Lac crores.

With every bull market phenomenon we are seeing new leadership in the markets. Consumer, Pharma, Cement, Private Sector Banks and Media & Entertainment are the sectors showing this new leadership. The markets made a low on December 20th, 2011 and have since been climbing a wall of worry. There were no significant positive news flows between December 2011 to August 2012. In this period of gloom and doom the FII’s were consistently absorbing supply made available by domestic investor’s redemption and we've come to a point where after the reforms announcement in September 2012 the market is gearing for some momentum.

There is a classic difference in return expectations of FII’s and domestic investors. The returns available in developed markets are very low and hence they’re making a beeline to buy Indian businesses which offer better growth. This is in contrast to domestic investors who have made decent returns in gold and real estate in last many years. Their expectation from equities are bench-marked to returns from such alternative asset class. We expect this mismatch to continue and will force domestic investors to sell equities to FII’s.

In our view we may be just 7% from a new high but the journey till then will not be smooth. We are anticipating large domestic selling which means that volatility may increase once we get close to the new high. This is the time for the investors to correct the skewed asset allocation in fixed assets like gold, real estate and fixed deposits. Our allocation to equities has been negative for the last 5 years and its time we take a fresh look at the asset allocation and correct underweight and overweight positions. This will help us to participate in Indian equities if market scales new high.