Indian equity markets have staged an impressive rally in the past couple of weeks. One major reason for this was the rather subdued growth in equity markets in last 6 months after the initial recovery. Once the markets caught up to the fundamentals (and probably went a little further), suddenly everyone seemed to be looking around for reasons to justify higher levels. There were not many and that showed in the range bound markets for last 6 months.
Interestingly nothing major has happened in the last month either. Domestically that is. Of course the monetary policy stance is becoming less aggressive, inflation is waning, IIP is rising and GDP forecasts are getting better. But none of this is 'news' and to that extent has largely been factored in the markets. The real change in my view is on the foreign investors' front. Many investors in the developed economies seem to be over their fears now and are back into the hunt for returns. The other thing that works in India's favor is the a robust economic growth through the crisis and absence of any obvious signs of bubble (unlike China). Thus the cheap money is at our gates again!
Is it a problem? Not now, not necessarily in future either. But it can be worrying for us in two ways. For one, the returns that foreign investors are willing to settle for are lesser than what we may demand as investors standalone. This forces domestic investors to also settle for the same returns or lead to inflated asset values. Secondly, the return of this money in troubled times rocks our asset markets more than they deserve to on the back of their performance. This is simply the "curse of shallow but attractive asset markets". We will continue to have it till the size of our economy and asset markets grows to a few times its current level (at current growth rate, maybe another 10 years).
What do we watch out for? There is no easy way to make money by second guessing FIIs. A more realistic strategy would be to avoid making losses due to their behavior. That means avoiding entering markets in a euphoria driven by non-domestic factors (US employment data, good results of stress tests in EU etc) and more importantly avoiding booking losses in a fall driven by FII exit due to non-domestic factors. Summary: let the investors be domestic or foreign, make your decisions domestic!