FIIs overweight on India, but valuations may be a concern later

Powered by strong fund flows from foreign institutional investors, Samvat 2065 saw the benchmark index of the Bombay Stock Exchange rise 92 per cent. And the party looks set to continue in Samvat 2066, with most FIIs saying liquidity flows to emerging markets such as India will only improve in tandem with the stronger economic recovery across the globe.

The consensus among FIIs is valuation could be a concern going ahead, but that is still some way off.

“FIIs, by and large, may continue to remain overweight on India in the next Samvat year as well. India has a good growth story supported by strong fundamentals,” says DSP Merrill Lynch’s Head of Research Jyotivardhan Jaipuria. He believes markets are no longer cheap, but they probably have some way to go before they can be considered to have entered bubble territory.

FIIs made net investments of Rs 63,577 crore during Samvat 2065, of which the last quarter alone accounted for about half. Of the 60-odd A-group companies that have released shareholding data for the July-September quarter so far , FIIs have raised stakes in more than 40 firms across sectors.

According to Morgan Stanley analysts Ridham Desai and Chetan Ahya, increases in private consumption spending and higher government expenditure are driving the recovery. “But over the next six to nine months, we expect the investment cycle to accelerate the pace of recovery as capacity utilisation improves,” they say.

The rebound in global capital markets implies that investment proposals are likely to start rising from November and December. Most market players reckon that growth over the next 12 months is likely to be more sustainable though lower than the pre-crisis performance.

According to Morgan Stanley India, corporate earnings should recover because economic activity has clearly rebounded (particularly in China, India, Brazil, Indonesia, Poland and Israel). There was a 14-month period of earnings recession, Morgan said, but that seems to have ended with the quarter ended September.

Another reason India and some other emerging markets look attractive is that currencies have risen significantly against the dollar since the second quarter, boosting the dollar value of local earning streams. “Our top-down earnings model currently forecasts the earnings per share to grow by 28% in dollar terms during calendar year 2010. This places the MSCI Emerging Markets index on a prospective 2010E P/E of 14.4 times,” a Morgan report says.

Barclays Capital predicts that the currencies of India, Korea, Taiwan, Brazil and some other emerging markets will appreciate further.

Barclays also believes the rally in markets will continue. Valuations are, of course, far less compelling than they were earlier this year. But it doesn’t think valuations are yet overly stretched.

The FII, however, adds a note of caution: “The time may very well come when valuations and investor positioning make emerging asset markets vulnerable to a sharp correction – it may even come before the end of the current quarter but it is yet to arrive.”