Why foreign investors are interested in the stock market again

"My father has been very happy of late," she said, stepping into my room with a view.

"Why?" I asked.

"Oh, the stock market has been rallying again."

"And that makes him happy?"

"Yes," she replied. "Brightens up the old man's day."

"Well."

"Tell me V, what is happening?"

"The foreign institutional investors are back."

"Are they?"

"Pretty much," I replied. "Between February and now (April 10, 2019), they have net invested Rs 62,211 crore in Indian stocks."

"Okay, that's interesting."

"This after they net sold stocks worth Rs 33,014 crore in 2018."

"Why this change?"

"The FIIs continued to be bearish in January 2019 as well. They net sold stocks worth Rs 4,262 crore even in January. But early morning on January 31, 2019, things started to change."

"What happened?"

"The Federal Open Market Committee (FOMC), which decides the monetary policy of the United States, decided to keep the interest rate unchanged."

"Oh."

"Up until then it had been on a rate raising spree, making it difficult for the foreign investors to borrow easy money and invest in India."

"How did this impact India?" she asked.

"So, in the aftermath of the financial crisis of 2008, the Federal Reserve of the United States, the American central bank, printed and pumped money into the financial system to drive interest rates down."

"Yes, you have told me this."

"The idea was that at lower interest rates people will borrow and spend more, and companies will borrow and expand. But that did not happen to the extent it was expected. Companies borrowed to buy back their shares. With fewer shares out there, earnings per share went up, and stock prices went up as well."

"Yes."

"Also, many big financial institutions started borrowing in dollars and invested that money in financial markets all over the world, including the Indian stock and debt markets. In the recent past, the FOMC has been raising interest rates. In this scenario, the profitability of raising money in the US and investing it in India, had gone down."

"All this you have told me before."

"Yes. On January 30, 2019, which was early morning January 31 in India, the FOMC decided not to raise interest rates. This was also done in line with the expectation of the US economy slowing down."

"Okay."

"The interesting thing is that there is a huge expectation that the FOMC will cut interest rates going forward."

"Hmmm."

"Any financial market works on factoring in expectations. With interest rates in the US likely to go down, the chances are that the foreign investors will find borrowing in the US and investing it in financial markets across the world, including India, as profitable as it they used to earlier. In fact, they already are."

"Okay," she replied.

"Which is why more than Rs 62,000 crore has come into the stock market since February. In fact, this rally started on January 31, 2019, when the foreign investors invested more than Rs 3,000 crore in the stock market."

"Oh..."

"Yes. On January 31, 2019, the Sensex rallied by 1.9% to close at 36,257 points. Between January 30, 2019 and April 10, 2019, the Sensex has rallied 4.8% to close at 38,545.25 points. In fact, the FOMC decided not to change interest rates after the meeting of March 19-20, as well"

"That's quite a rally in this moribund economic environment."

"Yes. This is reflected in the price to earnings ratio of the stocks which comprise the BSE Sensex. On April 10, 2019, it stood at 28.17. Such PE levels were only seen during the dotcom bubble of mid-2000."

"What about the domestic guys?"

"The domestic institutional investors have been selling. They have net sold stocks worth Rs 16,018 crore, between February and April 10."

"Okay."

"We are at a Ponzi stage of the market. Prices are simply going up because of the foreign money coming in and not because the earnings of the listed companies are likely to go up."

(The example is hypothetical)

Vivek Kaul is the author of the Easy Money policy.