India Funds Lead World -- Rebound May Be Short-Lived


India -- one of the year's worst hit stock markets this year -- staged a dramatic turnaround in October, soaring to a record high in local currency.

India mutual funds rallied 10.68% in October although they're still the year's worst-performing region, down 12.98%. By contrast emerging-market funds added 4.22% in October, lifting year-to-date gains to 1.33%. The average world equity fund rose 3.51% and 14.27% over the same periods.

The most significant catalyst in turning around investor was Raghuram Rajan, former chief economic adviser of the Ministry of Finance, taking over the Reserve Bank of India, says Neena Mishra, director of ETF research at Zacks Investment Research in Chicago.

Rajan announced several measures to halt inflation, make the financial markets more open and competitive and strengthened the rupee, which had rebounded 12% off its late-August low.

"I believe that sustained recovery in the market would be possible only if the Indian government shows the willingness to implement key structural reforms and curb the widening fiscal deficit," Mishra said in an email. "But with elections due next year, any significant push to reform or to curb populist measures like ballooning subsidies should not be expected anytime soon."

India's economy has also benefited from a correction in crude oil prices -- one of its biggest imports -- and corporate earnings surprises. From a high of $112 a barrel in late August, light sweet crude has tumbled 14% to $96 currently. India's stock rally has been fueled mainly by the exporters whose profits are being boosted by a weak rupee, says Alec Young, global equity strategist at S&P Capital IQ.

"There are few signs of a real pickup in growth," he said.

The central bank raised the key interest rate for a second month straight in late October to 7.75% to control inflation. Inflation, currently running at 9% for consumers and 6.5% for wholesalers, far exceeds the bank's comfort zone of 5%.

The RBI will likely have to raise rates by 25 basis points again at its December meeting and it will take 12 to 18 months for the economy to feel the results, Credit Suisse analysts say. The country's current account deficit is larger than it was in the run-up to the Asian financial crisis, Credit Suisse wrote in an Oct. 29 Global Equity Strategy report.

Yields on India's 10-year bonds have surged to 8.63% at month's end. That's nearly on par with Greece, one of the world's most poorly rated debtors. The current account deficit at nearly 5% of GDP (vs. a sustainable level of 2.5%) and rising interest rates could push the country's credit rating into junk territory, says Surendra Kaushik, a professor of finance at Pace University's Lubin School of Business.

"The political environment, excessive public spending programs on consumption, labor market imperfections, corruption and low business confidence are likely to keep things the way they are for a while," Kaushik said in an email. The government will not likely pursue aggressive economic reforms in the near future with elections in five states in December and national parliamentary elections in mid-2014, he added.

China funds added 2.95% in October and 7.72% year to date. Latin America picked up 2.57%, paring year-to-date losses to 8.55%.

Investor Fund Flows

In October, investors poured $54.2 billion into all-stock mutual funds and exchanged traded funds -- the third-highest monthly inflow on record, according to TrimTabs Investment Research in Sausalito, Calif. Global equity funds absorbed $27.6 billion in inflow, eclipsing inflow of $26.7 billion into U.S. equity funds.

What's most remarkable is that global funds have only about a third of the assets of U.S. stock funds at $2.2 trillion vs. $6.0 trillion. Global equity funds have absorbed disproportionate inflow for three straight months. They attracted $61.4 billion from August through October vs. $17.9 billion for U.S. stock funds.

"Fund investors tend to be wrong, and recent flows have been skewed enough that we think contrarians should consider favoring U.S. stocks over offshore stocks," TrimTabs wrote in a report released Monday. "Our demand indicators (which use 21 flow and sentiment variables for intermediate-term market timing) suggest the U.S. stock market may struggle to move much higher over the short term, but that the longer-term uptrend is secure. While the S&P 500 is up 23.5% year to date, our indicators do not point to a major sell-off anytime soon."

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , Mutual Funds

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