Stay Away From the Indian Market for Now (IFN, IIF)

Recently, the Indian market has suffered a rather painful correction for anyone who was invested there. And now there is a dilemma for investors: Is this the bottom, or is there more to go?

The Indian story is unique in certain aspects. First, it is driven in a large part by domestic consumption (unlike by investment and exports as in China). Second, high commodity prices are not the primary cause behind the prosperity of the last few years (unlike the Middle East and Brazil, where commodity exports make up a big chunk of the economy). As such, even if the US economy slows and commodity prices soften, the Indian growth story should remain untouched to a large extent.

But when we talk about stocks, things are a bit different. For stocks are impacted not only by underlying fundamentals, but also by liquidity flows. And that is where the concern lies.

Currently, foreign investors are key players in the Indian markets, through various emerging market funds and hedge funds. And so, if the foreign investors were to yank money out of these emerging market funds, these funds would be forced to sell securities that they hold, including Indian securities.

So while the Indian story is different in many regards, it is clubbed together with other emerging markets for investment purposes. Where the emerging markets go, so will India. And so the key question becomes are US, European and Japanese investors going to be withdrawing money at a rapid clip out of these emerging market funds?

I doubt whether anyone will know the answer to this question for the next two months. The next Fed meeting is on June 29th. Till that time, I think the US market is going to get conflicting reports on where inflation and economic growth are headed. So while there will be a lot of volatility in the US markets, it will not be in any particular direction.

After June 29, the focus will shift to when the Bank of Japan raises its short-term rates. It could happen anytime between July and September, which would create another uncertainty in the markets.

Bottom line: I think that investing in Indian stocks will remain a risky proposition at least until July and possibly until September. But the growth story exists in India - between January and March 2006, the economy grew at 9.3%. So when the time is right, stepping into the market could produce a number of winners. That time however, is not now.

India BSE 30 Index weekly chart:

(Click to enlarge)

20 week exponential average in green, 5 week exponential average in red, 52 week ROC (rate of change) in yellow, MACD (moving average convergence divergence) in green.

[Editor's note: Examples of funds that invest in the Indian market include Advantage Advisors' India Fund (IFN) and Morgan Stanley's India Investment Fund (IIF)]