FIIS PUSH MARKETS UP

The stock markets are in an upward momentum. What should an individual investor do? Shubha Ganesh analyses

It has been a year in which the stock markets fell and rose dramatically. It has been a year that tested the investor's faith in the stock markets. The markets in 2008 and 2009 had all the ingredients that go into the making of a blockbuster movie. The euphoric highs of January 2008, the persistent declines which robbed investors of their wealth, jobs and homes, and reports of gloom and doom that took the markets to an abysmal low of 2,200 levels in the Nifty.

Just as investors reconciled themselves to a few years of bear markets came a ferocious rally that left them stunned and speechless. Like the blockbuster movie a happy ending after many trials and tribulation. In a short span of six months, the markets have doubled from the lows leaving individual investors lighter in the pocket but much wiser after the experience.

FII factor   

The reason for such dramatic changes in the market direction seems to point towards the foreign institutional investors (FIIs). A truth that cannot be wished away is that FIIs decide the direction of the domestic markets to a large extent. Markets go up sharply when they buy and fall when they sell. Last year, they accelerated the downfall in the indices by their persistent selling from January to October. Their view was that the economy here, along with global markets, would suffer a protracted slowdown. It under-performed most global indices last year and fell more.

Now, the FII view is that India, along with China, will lead the next bull market in the world. This star billing for India has attracted a mind-boggling Rs 313 billion into equities in less than three months.

1991 again

Post elections, the FII view on India has changed dramatically. This fact has been reinforced by the fund flow from FIIs after the election results. They feel the government will now be in a position to actively bring in reforms on a number of fronts and that will make all the difference. For example, the Pension Fund Regulatory and Development Authority Bill, introduced in the Lok Sabha in 2005, could not be passed by the last government due to lack of support.

The FIIs expect pathbreaking reforms and a further shift to a market-based economy. The markets expect the new government to pull out all stops and unleash a slew of reforms in insurance, banking, and retail. Reforms in pension funds, sale of public sector undertakings, large infrastructure spending, and increase in FDI access to civil aviation are expected. Another key expectation is that small public sector banks will be encouraged to merge. The wishlist seems endless. Basically, they expect a focus on economic reforms that will stimulate growth and consumer spending to help the economy recover from the slowdown. Hence, the budget will act as an important catalyst in determining the movement of the stock markets.

Investment strategy

The markets, over the last year, have held many lessons for individual investors. The first lesson is that stocks quoting at distressed valuations give handsome returns. Investors with a strong faith in the stock markets bought stocks then and are generating 100 percent returns on their portfolio now. The lesson here for investors is that investing in quality stocks when markets are in a state of utter panic and holding on to them patiently till the market view changes in your direction is good.

The second lesson is that sharply moving markets tend to correct equally sharply, leaving little time to think and act. So, be decisive and invest in fast-moving markets. Another interesting aspect of the current rally is that small-cap, midcap and growth stocks have been in focus. It is often said that these stocks tend to be the leaders when coming out of bear markets. Does it mean bear markets are over?

It could also be the markets are over-correcting as a compensation for falling very sharply last year. The markets tend to return to the mean over time. Excesses in one direction lead to an excess in the opposite direction. Whether it's extreme optimism or pessimism, the markets eventually revert to the sane long-term valuation levels. In the current rally, stock prices have nearly doubled. These valuations can be justified only in the case of a decisive end to the economic downturn.

Finally, such and end of economic woes has to reflect in corporate earnings. That is the key for any investor. This rally is still having steam on the expectations that the government's path-breaking reforms will bring about a dramatic shift in corporate earnings. Any mismatch in expectations and reality could set a tone for reversal in the markets.

So, stay invested in the expectations of the new bull markets, but be ready to lock in your returns if the government is not as reforms-ready as the markets.

Courtesy:- ET dt:- 07-06-2009