Points to ponder

Results season is upon us again and this time they’re likely to make or break the market. The stock market is within hailing distance of its all-time highs and valuations are steep, making it the most expensive emerging market. Most brokerages, the foreign ones in particular, have been calling for caution and much of recent FII buying has been to take advantage of arbitrage opportunities between the cash and futures markets.

At the same time, everybody expects the second-quarter corporate results to be good. The macro numbers have been very encouraging and if you go by the advance tax paid by companies, they’re minting money hand over fist. Much of the caution, however, is linked to the results, because the markets are priced for perfection. If they’re better than expected, the market will take off. If they aren’t, it will crash.

A closer look at the sensex shows that although it’s at the same level as on May 5 this year, there are several differences between then and now. To start with, only a third of the sensex stocks are higher today than where they were on May 5. Three of them are at about the same level, while as many as 17 stocks are lower than where they were as on that date. The sensex has been dragged up by the banks and Reliance, with the cement and telecom stocks and one IT firm also outperforming the sensex. The rest of the sensex have been laggards.

Clearly, the recent fall in yields has led to the banks becoming the leaders in this rally. Among the BSE indices, it’s only the bankex, the IT index and the teck index that are currently higher than where they were on May 5.

The mid-cap and small-cap indices are much lower while broader indices such as the BSE 100, the BSE 200 and the BSE 500 are all below the levels they reached on May 5.

In a recovery, it’s the frontline stocks that go up first, and it’s no surprise that the mid and small cap indices are taking longer to recover. But they’re catching up pretty fast. For example, between August 1 and October 6, the sensex has moved up by 15.2 per cent, while the mid-cap index moved up by 22.2 per cent, and the small-cap index by 22.9 per cent. In future, therefore, the smaller companies will outperform the frontline stocks. That’s not only because of the catching-up effect, but also because these companies have been able to lower their cost of funds through external commercial borrowings and because their expansion plans should result in substantial economies of scale.

Fund flows

Recent data from TrimTabs show that US-based stock mutual funds had a net outflow of about $650 million in the week ended October 4. Emerging Portfolio.com says that US equity funds have now lost money to redemptions in seven of the eight weeks to September 27.

Year-to-date flows into US equity funds are into negative territory. Within the US, money is flowing from small-cap to large-cap funds. At the same time, global equity funds continue to pull in new money. Among emerging markets, it’s only China and India funds that are attracting money.

Before the May meltdown, fund flows to emerging market funds this year were almost double of those to global funds, while US funds were bleeding. At present, inflows into global funds year to date are more than inflows into emerging market funds.

In short, while money continues to flow out of US funds, this time they’re getting globally diversified, rather than flowing to emerging markets.

The India story, however, is still attracting money. Whether it will continue to do so depends, to a large extent, on the company results.