Mutual Funds and the Bullishness of the Indian Stock Market
With the increasing participation of Domestic Institutional Investors (DIIs) and Foreign Institutional Investors (FIIs), the Indian stock market has seen a rise in liquidity. This influx of capital is largely attributed to mutual funds and asset management companies, which have been significant players in shaping market trends.
Understanding the Role of Mutual Funds in Liquidity
There is a simple inverse relationship between FII and DII activities. When FII investors sell, DIIs tend to buy, and vice versa. This dynamic helps in stabilizing the market to prevent abrupt drops. However, in 2017, both FII and DII were net buyers in the Indian equity markets. This positive sentiment is complemented by the actions of asset management companies and popular mutual fund schemes, which have significant cash reserves.
Currently, many big asset management companies and mutual fund schemes are holding cash as high as 10% of their total corpus. Instead of fully investing this cash, they are scouting for avenues of investment. Some have even stopped accepting new investments through Systematic Investment Plans (SIPs) and Lump Sum investments. This practice is indicative of the confidence these companies have in the market's future prospects.
Key Factors Contributing to Market Optimism
The optimism in the Indian stock market is fueled by a few key factors:
1. Expectations Post-Demonetization
After the demonetization drive, there was an initial concern that corporate earnings would be adversely affected for 2-3 quarters. However, the third quarter results of Indian companies largely disappointed the market, but they recovered sharply in the fourth quarter. This recovery brought the results in line with market expectations, fostering a sense of optimism for the near future.
Markets are known to discount every piece of information, and sentiment plays a significant role in shaping market behavior. If earnings in the first or second quarter of FY18 fail to meet market expectations, there could be a sharp fall in the indices. Conversely, positive news could push the market higher.
2. Market Consolidation
In the last 10-15 trading sessions, the Indian indices have consolidated. They are trading in a range of 9470-9600, which may be critical support and resistance levels for the next month. Markets need significant optimistic or pessimistic news to break these levels.
The Test of Market Resilience
The real test of market resilience will come when the markets are down for a considerable period. The current high levels of Assets Under Management (AUM) for mutual funds indicate that these institutions are flush with cash and ready to invest. This is a positive sign, as it means that the Indian market is less dependent on the whims of FIIs.
It's important to note that apart from mutual funds, other institutional players such as Employee Provident Fund Organization (EPFO) and insurance companies are also actively buying. The participation of DIIs in the market is at record highs, which is another encouraging sign.
Investment Perspectives
From a broader perspective, everyone is expecting growth in earnings, and the signs are generally encouraging. This, along with a fall in interest rates in debt instruments, is driving both DIIs and retail investors to look at the market as a vehicle to generate good returns.
However, the market is also influenced by the irrational behavior of investors. Any slight negative news can potentially derail the market rally, even if it's only for a short term. Investors often rush to sell in times of uncertainty, while it's the long-term investors who generate significant wealth.