Are we headed in the right direction?

Some analysts claim that the recent rally in Indian market is largely driven by liquidity flows rather than actual fundamental state of the economy. But, despite these record FII inflows, the market is in no mood to rally. I think, FII flows are largely diverted into OFS and primary issues as they under own some good names like Oil India, et al. The selling by DIIs is only 1/4th of the FII inflows in Jan of Rs. 22,000 crore and going by the net inflows of ~Rs. 15 to 16K crore in Jan, the market should be now trading at a much higher levels. This suggests money is largely diverted to OFS and primary issuances rather than to the broader (secondary) markets. January alone saw ~22% of last year FII inflows of Rs.1lakh crore largely because FII who missed last year rally have started to allocate to EM (esp. India) – this is nothing but the initial portfolio allocations that happen every January - but this has hardly moved the Indian markets.

Are there any larger signals which many analysts fail to read? May be! The currency war started by Japan is now taking an interesting direction. Dollar/Yen has rallied by close to 20% in the recent months and the last time it did this it was just ahead of the Asian crisis of 1997. However, the Current Account numbers in the rest of Asia are more balanced now than in 1997 (esp. for the so-called ASEAN-5 countries: Indonesia, Malaysia, Philippines, Thailand and Vietnam); however we cannot ignore this fact. Dollar is slated for a strong up surge that will take rupee to ~60 within next few months. This dollar surge will put pressure on commodities as a basket (esp. gold to take a big hit although partly supported by weak rupee). Gold Bugs can refer to my earlier article “2013: Tipping point for gold? “.

Real asset behaviour was always a clearest indicator of these bubble risks - be it gold or real estate! The dichotomy between excessive property-price strength and export weakness (may be out of yen’s slump) intensifies, something will have to give for sure. It could be a significant weakness in currencies, stocks or some other financial dislocation(s) which in my view in turn would set off strains in other countries where currency links to the dollar are not as close (esp. India); and given the closeness of all these market, I think the weakness will be across the board. Asia is  better than 1997 and it may not be a full blown crisis, but tensions might prevail  and I think Asian currencies (esp. rupee) shouldn’t  be touched with a barge poll.

The European problem is like a cat sitting on the wall; don’t know where it will land up. And, with US in a deep debt mess amid domestic issues at hand, I think the upside seems to be capped for the Indian market; while at the same time last year levels should provide some support. To put this in numbers, we would be trading within a +/-15% band from the current levels for the next 12 to 15 months.