The Hindu Business Line : Foreign broking cos turn cautious on equity market

FOREIGN broking firms, whose advice drives FII inflows, have turned cautious on the Indian equity market and feel that a fall in stock prices in the near term is possible.

Due to a slightly higher risk associated with the investment in equity market now, some of the firms have advised their clients to keep at least 10 per cent cash to buy shares as they decline.

Their views come in the wake of a sharp rise in the stock prices and key stock indices since May this year leading to an overstretched valuation of the Indian market in comparison to other emerging markets.

The traders have ignored some of the negative news like floods in western India and the rise in international crude price.

The huge inflows, over $3 billion since May this year, have led to an increase in foreign ownership in Indian companies leaving them limited scope for adding more stocks to the FIIs' portfolio, foreign broking firms said.

Since May this year, there has been an upturn in stock prices across the board due to huge inflows from FIIs, especially from Japan. Mid-cap and small-cap stocks have run up very fast; the BSE Sensex has risen by more than 25 per cent and the S&P CNX Nifty by 23 per cent during this period.

"A sharp rebound in corporate earnings witnessed from the 2003 financial year has translated into consistent earnings upgrades. However, with the appreciation in share prices too, we believe that most stocks are now discounting high growth rates, implying that any near-term disappointments on growth raises the risk of a significant correction," said CLSA, a leading foreign broking in a report released on Friday.

It said the recent rally, which has seen the Sensex scale new highs, has been driven by a surge in liquidity, rather than any positive change in fundamentals.

"For now, the market appears to be digesting all the bad news. However, any visible impact on second quarter results could provide the reality-check," CLSA said.

There is also concern among the foreign broking firms on the financial parameters such as price-book (P/B) value, price-earning (P/E) ratio for India as the value of these ratios are comparatively higher compared with other markets.

"India trades at a 30 per cent premium to the US price to book-value multiple, making it possibly the most expensive market in the world on P/B and implying that the market believes India's return on equity (RoE) is sustainable.

"We believe India's RoE is likely to decline in the next one or two years as capital spending causes asset turn to fall, margins normalise from the heady levels of 2004 (which is already happening) and the financial de-leveraging effect turns negative with higher interest rates," Morgan Stanley said in a strategy report.

The firm estimates that India trades at 35 per cent and 20 per cent premium on P/E ratio over emerging markets and Asia Pacific.

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