Funds scooped up Indian shares over the past week, betting on stronger earnings outlook after activity in the capital goods sector picked up, and there is a good chance of stock indices hitting record highs in the coming week. A mild correction in prices over the previous two weeks also encouraged buyers, particularly new overseas investors who had missed out on the earlier rally.

Although industrial output in June came in below market expectations, at 3.4 per cent annual rise, there were sufficient indications of accelerated growth in vital sectors. A drop in global oil prices despite the Middle East tensions should also underpin the outlook for India, which is a large energy importer.

“Expect solid recovery,” said an editorial in the Economic Times, India’s biggest selling business newspaper. “Quick estimates of industrial growth for June actually suggest strong revival of growth in the offing that is investment-led and focused on producer goods.”

While manufacturing, which contributes three-quarters of the industrial index, expanded just 1.8 per cent according to the official data, this could be because the index is largely a volume-based measure and may be underestimating value-added in the form of quality improvements, it said.

Capital goods production surged 23 per cent, helped by segments like electrical machinery that soared 69.2 per cent.

“It is true that the seeming uptick in capital goods output is on a very low base, and lumpy equipment, which may take several months to produce, can periodically lead to spikes in output. However, the figures do reveal that capital goods output during April-June has gone up by a credible 13.9 per cent. And first-quarter company results do seem to corroborate turnaround performance quite across the board,” the editorial noted.

Little surprise investors took the cue and grabbed opportunities to accumulate. The top-30 Sensex and the 50-share Nifty raced 3 per cent each in the holiday-shortened four-day trading week. The rally took both the indices to within hand-shaking distance off their respective record peaks – the Sensex closed at 26,103.23, not far from its 26,300.17 record on July 25, while the Nifty ended at 7,791.70, just 0.6 per cent off its all-time high of 7,840.95 hit on the last Monday of July.

Upgrades, top picks

With the worst of inflation now likely behind us, there are signs of an incipient cyclical recovery coming through following a reduction in policy uncertainty and an appreciable easing of macro pressure points, according to Nomura Securities.

“We expect growth momentum to intensify in the medium term on the back of ongoing efforts of the new government to revive growth, and for the market to re-rate on the back of tailwinds arising from both falling inflation and rising growth momentum,” analysts Prabhat Awasthi, Nipun Prem and Sanjay Kadam at the Japanese investment firm said in a report.

“As a reflection of our positive view on growth, we are upgrading our underweight stance on autos and industrials (infrastructure, construction and capital goods) to overweight.”

“Our new August-end 2015 Sensex target is 30,310,” the analysts wrote in the report dated August 12, based on a 12 per cent earnings compounded annual growth rate (CAGR) for the financial years 2014-17, compared with consensus of 15.5 per cent earnings CAGR, and 9 per cent re-rating of the market’s earnings multiple to 16.4 times from the current 15 times.

The brokerage’s previous Sensex target was 27,200 by end-2014.

Its top 10 stock picks are: Axis Bank, ICICI Bank, State Bank of India, GAIL, Coal India, Container Corp of India, Adani Port and SEZ, Tata Motors, Larsen & Toubro and HCL Technology. It also added, among others, Maruti Suzuki, Dabur, Cummins India, Havells India, ONGC and Just Dial to its “long-only” basket.

Equity funds swell

Foreign funds were the prime drivers behind the more than 20 per cent rise in Indian stock indices this year, and there are signs the rally is now drawing domestic investors in droves as well.

Local equity funds saw net inflows of Rs108 billion in July, the most in six-and-an-half years and the third month in a row of strong inflows, according to data from the mutual fund association.

Together with inflows in May and June, the domestic equity funds cash has swelled by the equivalent of $3.3 billion over three months, Deutsche Bank said in a report. While the momentum of inflows had started to build from last November, it became entrenched since May and should herald a sustainable trend moving forward, it said. A higher tax proposed in the July budget on debt-oriented funds has triggered a shift in retail allocation towards equities.

“The quantum of investments has not kept pace with the quantum of inflows, implying that local MFs may be building cash holdings, which may find their way into the market post some consolidation, in our view,” analysts Abhishek Saraf and Abhay Laijawala said in the report.

Data from the Securities and Exchange Board of India showed local funds invested Rs51 billion in July and a total of Rs85 billion over three months, both the highest since January 2008.

“The retail investor could be the next big thing,” wrote Citigroup analysts Aditya Narain and Jitender Tokas in a report to its clients, noting that domestic retail investors “have started tiptoeing into equities after shunning them for five years”.

Foreign holdings

Meanwhile stakes held by foreign funds are rising as the demand spreads to less fancied mid-cap and small-cap firms, indicating a deepening of the market. Foreign ownership in the top 100-500 companies jumped 13-15 per cent in the past quarter, helping the BSE-500 stock index to outperform the 50-share Nifty by 4 per cent.

“If market’s going to move, its mid/small caps that should groove,” the Citigroup analysts said.

Foreign institutional investors [FIIs] hold shares worth $315 billion (Dh1.1 trillion), own 22 per cent of the top 500 companies and are the market’s mover. “FIIs own more than one quarter of India’s largest companies and are the largest owner group,” it said.

With India’s economy beginning to pick up steam foreign appetite for debt is also gathering momentum. At $13.4 billion flows into debt in the year-to-date, they exceed equity inflows and there is more investment headroom.

“This is broadening India’s markets — and with new tilts (domestic to equity, FII to debt), should continue to liven up them up,” Citigroup said.

The writer is a journalist based in India