Trade carefully

Samvat 2062 ended last week with the proverbial bang associated with Diwali fireworks. A 60 per cent gain in stock prices is not something that traders would have anticipated as they clicked the mouse during the previous Muhurat trading. Last Diwali, the stock market was just starting to come out of a 13 per cent correction that had happened in the previous month. Since then, the markets went up for over six months, till mid-May. Then came a deep correction and, within one month, there was a 30 per cent decline in the market capitalisation of the Sensex. However, over the last four months, the Sensex has crossed its earlier high of May and seems to be willing to test even higher points. The speed of the recovery has been a surprise, and suggests an underlying bull run.

For most of the year, though, it required the conviction of foreign institutional investors (FIIs) to point the market upwards. Except for a brief period in May and part of June, when they found the markets over-heated and pulled money out of the country, FIIs have been investing large sums in the Indian stock market. But they have been doing that in other markets too""and therefore the buoyancy in India mirrors the price spurts in the US as well as other emerging markets. Could some of the explanation lie, therefore, in the global liquidity story""which might also explain the continuing global growth story?

In the Indian market, investors shifted their focus during the year from mid- and small-cap stocks to the large-cap ones that are reflected in the Sensex. While the Sensex has gained about 60 per cent, the BSE Mid-cap index has risen by less than 40 per cent over the position a year ago. This is a reversal of trend, because mid-caps had done better than large-caps in the past few years, but investors realised in the last few months that the larger companies had become cheaper than the smaller ones.

What should be expected of Samvat 2063? The markets are near a new high at the beginning of the year, and it is logical that they will need to pause before long and take a breather. What can drive values still higher is strong corporate performance (the second-quarter results have pleasantly surprised most analysts), and the fact that the economy is still on a roll; if anything, it seems to be gaining momentum. The danger is that interest rates will climb further, too. Investors would already have factored in some increase as domestic liquidity has tightened somewhat; if the rate hikes are sharper than anticipated, it will certainly cool sentiment. As for foreign investors, they have returned to emerging markets; considering India's corporate and overall economic performance, it will merit greater weight in many portfolios, even if the valuations are high. In many ways, therefore, this has become a momentum market in which high valuations are not a deterrent for the time being. But as has been the case for several weeks, the danger signals are also there, in that trading volumes have been thinner than before, and there is no breadth to the bull run; a great many stocks are being left behind and no longer catch investors' fancy. The danger is that retail investors, who have not been conspicuous players, will re-enter the market just as it peaks.