Positive attitude

Mutual funds have turned equity buyers in the last two weeks

Domestic mutual funds, after being net sellers of equities every month since May 2004, have become net buyers of stocks again. During the second half of the current month (till December 28), they bought a net Rs 398 crore worth of stocks, being net buyers, albeit in small quantities, nearly every day.

True, mutual funds continue to be net sellers of equity this month at Rs 386 crore till December 28, but that's because of the selling seen in the first half of the month.

The change of trend in the second half comes after mutual funds sold a net Rs 2,170 crore worth of equities between June and November.

The question is: if the change in trend holds, what does it mean for the stock market? One obvious way of looking at the issue is to contend that net foreign institutional investor inflows will now be reinforced with net mutual fund inflows, strengthening the rally.

The case for domestic investors investing a larger portion of their portfolio in stocks has been a compelling one, given the fact that the proportion has been falling and because of the low returns available elsewhere.

On the other hand, a look at previous episodes when domestic mutual funds were net buyers is not very encouraging. Recall that mutual funds were net buyers of equities in March, April and May 2000, when the tech rally peaked.

August, September and October 2000 also saw net purchases by mutual funds. Similarly, mutual funds were strong net buyers in December 2003 and January 2004, again at the peak of the rally. Given this background, the change in trend in mutual fund behaviour may be an indication that the market is about to top.

Debt market outlook

The debt market is critically poised at this point of time. Liquidity is abundant but banks are cautious in investing in government securities to avoid depreciation in the market portfolio, especially after burning their fingers in 2004.

The main reason for the liquidity crunch lies in the pick-up in bank credit, which has been growing at around 16 per cent. In fact bank boards have asked their treasury departments to allow liquidity to flow into credit.

On the interest rate front, inflation has been moderating, thanks to lower oil prices. going forward the base effect will also see lower inflation numbers.

However, to acheive the target of 6-6.5 per cent inflation for the fiscal end, the RBI will have to undertake policy measures to ward off the impact of excess liquidity from the money supply.

Liquidity is expected to continue with sustained flow of foreign exchange inflows from portfolio investors. January will witness liquidity influx from advance taxes, inflow from special deposit scheme and government expenditure.

The government is maintaining a credit of around Rs 40,000 crore with the RBI, which is a moderating influence on the bond markets.

Centurion Bank: a long way to go

The latest bank to announce its plans to raise capital is Centurion Bank, which now has a capital adequacy of 9.51 per cent. At its current price of Rs 17, the price to adjusted book value (as in March 2004) stands at Rs 15.88, although, to be fair, there's plenty that has changed at the bank since March.

But with market leaders HDFC Bank and ICICI Bank trading at an historical P/ABV of 5.4 and 3.2 respectively, Centurion does seem overpriced. True, the bank is in a takeoff stage""- but it does have a long way to go.

The bank has a strong retail business, which accounts for 80 per cent of income, but most of this is in the two-wheeler and commercial vehicle segments, which are not the fastest growing segments.

So while it may have grown its retail assets by 80 per cent year-on-year in Q2, this growth will taper off as the higher base effect comes into play.

The bank must diversify into other segments""- which it has said it will. The quality of management may be comparable to the best but then the environment today is far more challenging , than it was when HDFC Bank started out.

In fact, the yield on advances in Q2 actually fell to 9.6 per cent y-o-y from 10.2 per cent and if the cost of deposits hadn't dropped by over 100 basis points, the spread would not have gone up.

In a rising interest rate scenario, it would be difficult to keep down deposit costs, even if the proportion of current and savings accounts grows. Even if the market views the bank as a potential takeover candidate, the premium seems to be overdone.

 With contributions from Anindita Day and Shobhana Subramanian