May Facts

WITH Rs 8,247 crore (about 5%) pulled out of the system, May 2006 was immensely painful to most traders and investors. But the shenanigans of FIIs and mutual funds enabled interesting conclusions.

Until May 2006, FIIs had Rs 1,51,753 crore ($33 billion) invested in Indian equity and Indian mutual funds Rs 30,573 crore ($6.6 billion). This leads us to conclude that Indian mutual funds are 20% the size of FIIs. (1 USD = Rs 45.90)

The current exodus of funds was 5% which was easily absorbed by the Mutual Funds.
The question now is what happens if FIIs decide to move out anyway, and Mutual funds face redemption pressure.

Historically, there has been no pattern to FII and Mutual fund behavior in May, as the table shows, so to draw any conclusion would be difficult, however, in the last 4 years:

1. From 2004-2006, FIIs have always had sales in May
2. From 2003-2004 mutual funds have always had net purchases in May
3. In May 2000, the FII and MF investments were almost on par

In all likelihood May 2004 has been the worst May ever, since the net sales has been the highest at Rs 2,246.36 crore. Compared to May 2004, net sales has been only Rs 674 crore this time.

Radio FM!

VOLATILITY in the Indian stock markets is mainly due to the shenanigans of FIIs and Mutual Funds. Even our Finance Minister, P. Chidambaram believes this, else why would he have kept harping on television that mutual funds have enough money to absorb any FII exits; and that retail investors who have a long-term view should stay invested, make informed investments, and if they cannot do this, shift to investing in MFs!

Our FM was giving directives to investors about long-term investing, without clarifying what was meant by long-term. After all, India’s fundamentals could change in 5 years, and mutual funds are subject to market risk, and then again, not all of them have performed in poor market conditions.

What would happen if in 2 years we have an election, and a new FM comes along and tinkers with the financial system, for better–or worse–for worse. Would companies attract the same PE despite better fundamentals?

Perhaps this is not for the FM to say, but our dear FM speaks suavely on all occasions except when it is most required. The right thing for him to do was to have quit smiling, and clarify the CBT’s circular on taxing the FIIs, during market hours. Alas, too little was said too late. But he never stopped sheepishly smiling.

That our FM bleats such statements displays how immature we in the Indian stock markets are. You would rarely, if never, hear the Japanese finance minister, or the US Federal Reserve making such childish statements. They talk economy, fiscal deficit, inflation, interest rates and other such indicators. It isn’t that the US and Japanese markets there not driven by emotions; they are, but not by sentiments, and herein lies the difference.

May 2006: Butcher's Paradise

May 2006 was an awful month, with the Sensex falling 22% in 12 days, from 12658 to 9826, and the Nifty, the NSE index, slipping 23%, from 3772 to 2894. They subsequently recovered, but the fall marked an important change in the unbridled run of the Indian stock markets.

Characteristically of secular bull runs, the corrective fall was rapid and, for the agape bulls, without respite. Millions watched as their capital eroded, and disappeared especially those leveraged long in the stock futures and options segments. For the first time, in the last 2 years, was an intra-day circuit brought in to play, since the indices fell 10%–the maximum limit they are allowed to–and trading was suspended for 1 hour. The last time this happened was May 17, 2004, when the Congress-led UPA government came in to power.

Just a few days ago, everything about India was glowing, and within a week it appeared as if nothing was right. Every bit of positive news was ignored. Theories abound that the fall was anticipated because the index had run ahead of fundamentals or were linked to FIIs moving out of emerging markets.

When it was all over and done with, some important ideas came to fore:

1. No matter how good the fundamentals, markets will always fall
2. Indian markets are purely liquidity driven
3. Indian markets are now inextricably linked to the owners of this liquidity–FIIs–and since most of them originate in the US, the developments in the US economy will have a strong bearing on their behavior in India.
4. How the government of India taxes these FIIs would drive the Indian markets
5. FIIs are now not just investors but also traders (hedge funds)

Quite emphatically, the Indian markets are directly linked to the larger fate of the US markets.
Fundamentals are good up to a point, but beyond this, it is all about hot money chasing hot stocks, and hot money originates in the US.

FIIs have about $35 billion invested in India, and point to note is the current fall was a result of a mere $1.8 billion moving out. Now imagine if $5 billion did!

With this in mind, it has thus become important for Indian investors to watch inflation and short-term interest rates in the US. A buzzing US economy is good, but too much of the buzz would drive up inflation due to rising real estate, commodity and energy prices. Real estate is already slowing down, but oil and energy continues to be high.

In so far, the Fed has increased interest rates 16 times in a row, taking it to 5% in May, 2006, however recent numbers indicate that the US economy could be halting. The possibility of rates being hiked once again in June to 5.25%, has raised its ugly head sending investors scampering.

The reason such small indicators are lapped up eagerly is because the Fed has said that it is unsure of what to do in the current scenario, and its policy makers are watching the economic numbers just like everyone else. So, cues in the Consumer Price Index (CPI), the Department of Labor’s Job Report and the Weekly Unemployment Insurance Claims are watched closely, and interpreted to show where the US economy stands.

May’s 5% freefall in the Dow and Nasdaq was a result of the CPI report showing an increase of 0.6% in April 2006. What halted the further slide was the DoL’s Jobs report which said 75,000 new jobs were created–a figure that was lower than expectations–indicating that the US economy was slowing down. However it has now brought in a new demon: Fears that an economic downturn is in the offing!

With this in mind, June 2006 would be an extremely important month for investors in India.