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It seems to be a problem of plenty in the Indian stock market, with foreign portfolio investors and domestic institutions acting almost in tandem in buying all available quality stocks, but the worry is who will be the buyer when these holdings get liquidated to book profit.
Those worried about this "demand push rally" in these stocks include the market authorities, and several market participants are also of the view that the fundamentals and earnings will have to improve in the long term to justify continued high valuations.
While marketmen, regulatory authorities and policymakers are keenly awaiting the next set of corporate earnings, which will begin trickling in from the next week, a memorandum placed by the market watchdog Sebi before its board last month noted that the Indian stocks have seen a record flow from institutional investors in recent months.
While the foreign portfolio investors developed an increased appetite for the Indian securities -- remaining net buyers between February and July of 2017 and more than doubling their investments from the whole of 2016-17 in just four months of the current fiscal -- the domestic mutual funds also invested heavily in the stock market.
"With both the FPIs and the domestic institutional investors demanding securities for investment, there is a scenario of demand mismatching the supply of some good stocks (for instance, in the stocks where the FPIs have almost touched their ceiling and none of them are selling at present). This is also leading to a demand push rally in the said stocks," stated the Sebi report placed before its board.
The regulator further observed that "if and when the institutions start booking profits or managing liquidity crunches, there may not be sufficient demand to meet their offloading of the stocks and this can be a cause of concern to the authorities".
Some marketmen felt that this fear has partly already come true with recent sell-off in the markets.
The benchmark Sensex hit an all-time high of 32,686.48 on August 2, but has cooled down nearly 1,000 points since then. Still, it is more than 6,000 points up from its 52-week low of 25,717.93 seen in November last year.
The regulator noted that the negative correlation between the net investment of FPIs and DIIs was observed to have fallen sharply since the beginning of 2017, giving rise to a new trend of the two investor classes mostly being on the same side of the markets nowadays compared to the past.
Besides, the recent surge in inflows from the FPIs and the growth in asset under management of mutual funds and other DIIs have turned both these investors into net buyers.
In another significant change, the volatility has not seen any major spike in recent months and the blue-chip indices like the Sensex and the Nifty have rallied at a gradual pace while avoiding any sudden spikes or busts -- with the major one-day gains or losses being in the range of 1-2 per cent.
According to several marketmen, as observed by the regulator, the Indian stock market valuations are said to be on the higher side when one compares the price-to-earnings ratio of the Sensex or the Nifty with their own historic levels and the global peers in advanced as well as emerging markets.
"Some participants are of the view that it was liquidity, and not the fundamentals, that has been supporting the current rally. According to them, both the fundamentals and the earnings will have to improve in the long term so as to justify continued high valuations," said Sebi.
It also took note of the latest World Economic Outlook of the IMF (International Monetary Fund) that has warned that the rich market valuations and very low volatility in an environment of high policy uncertainty raise the likelihood of a market correction that could dampen growth and confidence.