In the past 12 months, the major market indices have gained about six per cent. This has come on the back of heavy FII buying while, at the same time, domestic institutional investors (DIIs) have been heavy net sellers. That pattern is due for change. We could see a situation where DIIs do some net buying and FIIs are net sellers for an extended period. There are interesting implications for prices.
In the last 12 months, the FIIs have made net equity purchases of something over Rs 114, 000 crore. In fact, June 2013 is the first month since May 2012, when the FIIs have been net sellers, to the tune of roughly Rs 8,000 crore so far this month.
In contrast, DIIs have sold a net Rs 79,000 crore in the past 12 months. DII were net buyers this month for the first time since June 2012 -they have so far, bought Rs 6,400 crore. Matching the FII versus DII numbers over the past year, it's no surprise that the market has seen net gains.
One month of pattern reversal could be an aberration. However, the underlying reasons for the reversal are fairly well-known and lead one to believe that this will soon be the new pattern. As everybody knows, the FII has been driven by easy liquidity provided by the US equivalent of the RBI, the Federal Reserve. The Fed has just announced that it will be looking to cut back on its quantitative easing in a few months if the US economic recovery continues. As QE cuts back, FIIs will tend to focus less on Emerging Markets like India and more on "safer" hard-currency assets.
In every stock trade, somebody offers cash while the other party tenders shares. If there is a lot of cash on offer, prices rise and more shares are supplied until a supply-demand equilibrium is reached at a higher price. Conversely, if there is a large quantity of shares being supplied, prices tend to fall until an equilibrium is reached at a lower level.
This is almost trivial in theory but the dynamics of price, supply and demand can get very complex in practice when we're talking about large volumes. Once in a while we can see extreme conditions. In jargon, there are "only sellers" when a huge number of shares are offered and there isn't enough demand at prevailing prices. There are also "only buyers" situations, where there are few shares being offered and there's lots of demand. Prices can move a long way when those scenarios arise.
Now, there are three broad sets of participants in the market - FII, DIIs and retail. Their net positions have to match. The FIIs have much deeper pockets. When they've been consistent net buyers as in the past 12 months, prices have to go up. If they become consistent net sellers, prices are likely to move down.
Obviously the quanta of buying and selling is important. On average, the FIIs have committed about Rs 10,000 crore per month, with a maximum net purchase position of over Rs 20,000 crore in September 2012. On average, DIIs have sold a net of about Rs 7,500 crore, with maximum sales of Rs 16,000 crore in January 2013. Retail has contributed the difference.
If we "reverse" the attitudes, and the FIIs indulge in net selling of those levels, a bear market is assured. The third participating segment, retail could be unwilling to make up the difference. The last two years have seen household savings moving away from financial assets. Retail tends to get spooked in situations when there is heavy FII selling. Retail also tends to be unhappy about investing in a politically uncertain environment and India is more or less guaranteed a messy unstable coalition in 2014.
This dynamic of bearish prices could start happening just as the Indian economy starts bottoming out. Macro-economic indicators are mildly encouraging at the moment. The last four months (Jan-April 2013) of industrial data as reflected in IIP shows a slightly positive trend. Inflation as measured by both wholesale price indices and consumer price indices is coming down. Earnings growth has also paced up somewhat in the past two quarters.
This situation of falling prices and improving fundamentals creates a decent investment case. The small investor will need to hold his or her nerve while prices are falling and politicians rotating in and out of power. Bear markets can be both deep and long. Systematic investment averaging down would be the best method to handle a situation where price might fall or stagnate for a year or more.
