Cover Story: Global Warming! Or, How the Bull Jumped Over the Earth; Pg 2

Which Countries Will The Funds Flow Into?
India, Taiwan, And China Are The Hottest Markets

Clearly, global investors are upbeat about the emerging markets, with fund-allocations to them expected to be better in 2000. Says Sunil Seth, 46, Director (Research), Indo-Suez WI Carr Securities: ''The valuations and growth-prospects of the markets will determine the allocations.''

THE STOCKS: The Focus Is On software, But Cyclical are In the Wings
While infotech will continue to be the hottest sector in 2000, the action will shift from pharmaceuticals and FMCG to other sector. Much, however, will depend on whether the recovery turns into a boom.

If you wanted to invest in the Indian stockmarket in 1999, there was a simple 3-letter formula on how to go about it: PSF. No, that does not stand for Polyester Staple Filament, but for Pharma, Software, and FMCG-the 3 hottest sectors during the year. Those who followed it made it good. Especially the software sector, which gave returns ranging between 500 and 600 per cent. But will it work in 2000? Not to a T.

At least one of 1999's torrid sectors will continue to be hot in 2000: infotech. Although software stocks tumbled on the Indian stockmarkets in early January, 2000, following the tech stock sell-off on the NASDAQ, analysts expect them to bounce back. Says R. Sukumar, 34, Fund Manager, Kothari-Pioneer Mutual Fund: ''The demand for infotech services is expected to be strong in 2000, with corporations planning to spend heavily on systems for e-commerce and other strategic areas.''

The same cannot be said of last year's other hot favourites: pharma and FMCG. Both sectors have had a good run in 1999. Sectorally, on the NSE, infotech stocks are trading at 170 times the P-E value of corporate earnings, pharma at 58 times, food and food processing 46.67 times, and personal healthcare 68.70 times, while the CNX S&P 500 is trading at 26.70 times. The scope for appreciation would depend on individual picks. M&A activity is also likely to be a powerful driver. Says Manoj Murarka, 36, BSE broker: ''What will drive the Sensex and stock returns are general economy-related stocks rather than concept plays."

To be sure, those valuations look attractive. Emerging markets as an asset class are trading at 16 times their 2000 earnings compared to 24 times for MSCI and 26 times for the MSCI All-Country World Indices (ACWI), making them an attractive destination. The MSCI ACWI is, increasingly used as the benchmark for international equity investing, replacing the MSCI Euro-Australia Far East (EAFE) Index, which excludes the emerging markets. The EAFE indices are used for investments in developed markets, including the infotech sector in Singapore, which is considered sophisticated enough to match allocations in the developed world.

Following stretched valuations in the US, Europe, and even Japan, investors are shifting funds from EAFE, which restricts investment to developed markets, to the ACWI. What is significant is the clear shift in the emerging market strategies of international investors. Earlier, international investors would take a non-index bet, focusing on specific stocks rather than a proxy for them. With the emerging markets evolving, things are changing and, consequently, global investors are looking at index-driven investment strategies.

Concurrently, for global fund-managers, investments in the emerging markets represent both risks and opportunities. The risk is on account of the fact that the emerging markets now account for more than 9 per cent of the MSCI ACWI and, at the same time, provide the bulk of that index's outperformance compared with the MSCI EAFE. The risk-reward relationship, favourable to the US over the last 5 to 6 years, is fast shifting to non-US equity markets. Underweighting these markets, therefore, could mean taking on benchmark risks. The Indian market, for instance, is the fifth-largest in MSCI's Emerging Markets Index. That is close to 1 per cent of the ACWI.

Says JM Morgan Stanley's Desai: ''When non-dedicated money flows into the markets, there is a paradigm shift to size. Not only are large markets preferred, but there is a preference for large-cap stocks too.'' The bottomline: investors who increase allocations to the emerging markets are likely to pay little attention to the macro-view, and focus on the top 100 stocks in the asset class in the top 8 to 10 markets, which can provide enough liquidity and exposure to protect them against the benchmark risk while offering revaluation opportunities.

Interestingly, more than 80 per cent of the top stocks are in the top 8 emerging markets (ranked by weight). Global investors will increasingly hike their allocations to the emerging markets, betting on stocks with high market capitalisation and good performance track-record. The top stocks in each market will, most likely, be on their favourites' lists. In India, that would, typically, mean stocks that have huge floating stocks and greater liquidity.

Will The Focus Be On Country Plays In 2000?
Global Sector Plays Will Be The Strategy

It's ironical, yet true. The more integrated the markets become, the lesser are the benefits of portfolio diversification. Earlier, fund-managers used to diversify portfolios simply by spreading funds across different countries. So, if markets declined in the US, the low correlation between various economies would help them hedge their risks. Now, global equity markets follow the same direction as they digest the same news. But sector-investing provides enough room to diversify portfolios.

Now, fund-managers are more sector-focused, investing in related or similar sectors across the globe. Recently, when tech stocks surged in the US, tech stocks across other global markets followed suit. When the tech stocks hiccuped on the NASDAQ, and US investors shifted to other sectors, like cyclicals and healthcare, a similar shift happened in other markets, including India, too. Global sector correlation is getting stronger as global markets are getting more integrated.

So, if commodity cyclicals, like aluminium or chemicals, become hot favourites in the US, such stocks will also do well worldwide. Says Joseph Mezrich, 34, Strategist, Morgan Stanley Dean Witter: ''Recent trends favour sector-plays across the globe.'' Adds Vivek Reddy, 37, CEO, Kothari Pioneer Mutual Fund: ''Sector plays are looked at across the globe. Today, the average investor too is watching the movement of stocks on the NASDAQ. Tech stocks cut across boundaries, and there are lot of connections between Indian and global companies.''

Most players expect 2000 too to be an infotech year, with the sector expected to draw the largest proportion of funds across global markets, including the US, Europe, Japan, and the emerging markets. In terms of valuations, infotech is the second-largest, after financials, in MSCI's ACWI. Technology is a globalising factor that is attracting global pools of capital in pursuit of limited equity supply. In 2000, the opportunities for investors will be to put their money on the leaders in the sector in the emerging markets, trading at a significant discount to their global peers.

Yet, there are contrarians. Like Templeton's Mobius, who is apprehensive of tech stocks. Says he: ''We are cautious on technology given the high valuations.'' If, as expected, y2k is, indeed, the year of tech stocks, India will be among the clear winners in the emerging markets. The reason: India has a highly-visible infotech sector. While Taiwan's infotech industry is highly skewed towards hardware, India offers a significant number of software stocks. Says Gul Tekchandani, 42, CIO, Sun F&C: ''The technology boom is here to stay, and one has to decide the right price for the stocks.''

Tech stock valuations, which had reached unsustainable levels, have seen the first leg of correction triggered off by what happened in the US. Yet, some tech stocks continue to trade at a p-e multiple of 150 times or higher. Adds Sundip Bhatia, 30, Head (Research), Warburg Dillon Read: ''With the earnings growth of infotech firms being 50 per cent-plus, 30 per cent corrections should make them attractive.''

Will The Boom Spread To Other Sectors Too?
Tech Stocks Will Set The Trend; Cyclicals Will Follow

True, tech stocks are hogging the limelight. From bourses in the US to the emerging markets, the hottest stocks are those of Net, software, and related companies. But there are stirrings elsewhere as well.

With stronger global GDP growth expected in 2000, analysts are forecasting an uptrend in global commodity prices. For investors, that is a cue to build asset positions in commodity stocks-in the US, as well as in Europe, Japan, and the emerging markets of Asia. Additionally, bank stocks had rallied in 1999 in response to financial deregulation in the US. This year too, financial stocks are in for a good run in the US, Europe, and developed countries in Asia. The financial sector is extra-sensitive to economic parameters as it appreciates stronger GDP growth. Other sectors in the US that may rally due to growth include auto, energy, leisure, household, and personal products.

In India, fund-managers expect the cyclicals-play to be strong in 2000. As things stand, with cyclicals as a group trading at 20 to 25 per cent lower than their valuations 5 years ago, cyclical stock-prices are low. But their growth-prospects are high. The reason: in several cyclical sectors, supply has contracted because of the Asian economic debacle of 1997 while demand is now moving up as global GDP growth improves. Says Ajay Srinivasan, 36, CEO, Prudential ICICI MF: ''True, there will be a sustained move towards cyclicals; yet, knowledge-based stocks, like infotech, life sciences, and telecom, will continue to provide investment opportunities.''

According to a report of the Mumbai-based DSP Merrill Lynch, 4 themes will offer good returns in 2000 in the Indian market: a play on the economic recovery and restructuring story (key sectors: cement and engineering); a play on global economy and attractive valuations (petrochemicals and aluminium), a play on strong growth and earnings surprises (software and pharma), and a play on the re-rating of PSUs (oil). Avers P.S. Subramanian, 57, Chairman, UTI: ''In technology, it is essential to differentiate between the men and the boys. Outside technology, the market is more broadbased, but the question is one of the right pick.''

Other Indian market-watchers, though, are optimistic. Shankar Sharma, 37, Director, First Global, expects to see money flow into ''all sectors except pharma and FMCG,'' which he feels ''have already had a good run, and the story is over.'' Counters Prudential ICICI's Srinivasan: ''The pharma story is alive and kicking. Knowledge-based stocks will provide opportunities.'' Adds Kothari Pioneer's Reddy: ''The risk of investment in individual tech stocks has gone up, while the return differential between infotech and other sectors has gone down. So, this year, the rally is bound to be broader.''

It's a worrisome question on everyone's minds, but no one wants to ask it aloud: how long will the party last? The US markets have confounded critics by climbing steadily for the past 5 years. That's way too long. The previous US bull run lasted 5 years before crashing in 1997. Does that mean global markets should prepare for a slump?

After all, what goes up has to come down. The bulls, for one, disagree. Says Rajkamal Iyer, 23, Analyst, Mecklai Financial: ''Contrary to conventional belief, there are studies which show that the bull run gains momentum as its length increases.'' By that logic, stockmarkets, which have broadened in the last quarter, could still have a long way to go.

But in this ephemeral world, nothing is certain. Take, for instance, the risks that the US market is facing. Although the unemployment rate has remained below 5 per cent for nearly 3 years, inflation-rates, at 2.90 per cent (annualised for last quarter of 1999), are up from 2.60 per cent (for the full year of 1999), and the US Fed is expected to take pre-emptive measures by raising interest-rates in February, 2000. If the Fed strikes, the casualty will be the already-overvalued US stockmarket. But the domino effect may not be homogenous across the globe.

The fallout of a slump in the US market-if it happens, that is-would be quite different in Japan and the rest of Asia than it would be in Europe, Hong Kong, and Singapore. Consider India: while there is a macro linkage with the global markets, the Indian market may have a more specific correlation with the US market-the key here being India's vibrant tech sector. Admits Uma Shashikant, 38, Assistant Professor, UTI Institute of Capital Markets: ''There is a linkage as far as tech stocks are concerned.''

That's possibly because Infosys and Satyam Infoway are also listed on the NASDAQ, where they act as a proxy for India's tech sector. Remarks Sanjoy Bhattacharya, 37, a Mumbai-based investment analyst: ''The listing of a couple of companies on the NASDAQ has led some people to believe that the tail is wagging the dog.'' Yet, according to HSBC Securities' estimates, the correlation between the BSE 100 Index and the Dow Jones Average, which was 0.90 per cent in 1998, has improved to 0.60 per cent in 1999. The same report estimates that the correlation between the BSE 100 and the NASDAQ has improved from -0.5 per cent to 0.7 per cent in the same period. Adds Arora of Alliance Capital: ''In the longer run, Indian markets don't have much of a correlation with the US.''

He could be right. At present, the US market expects the Fed to raise interest rates, but, in India, on the cards could be an interest-rate cut. The fact is that some local factors will continue to affect the fortunes on Dalal Street. Like Budget 2000. Traditionally, the budget is a big influencer of which way our stockmarkets move, and, this time, the stockmarket is hoping for the best. Says U.R. Bhat, 43, cio, Jardine Fleming AMC: ''If the budget goes further on the reforms, the stockmarkets will soar. But, if it is a half-way effort, the Sensex will move sideways.''

A good budget or not, bulls will be bulls. Jardine Fleming expects the Sensex to touch 7,200 by end-2000. Exults First Global's Sharma: ''India is in for a 5-year bull run.'' An inveterate bull, he expects market capitalisation to zoom from $250 billion to $1 trillion 2 years. If that happens, India will truly find a berth in the big league of global markets, rubbing shoulders, perhaps, with the US (current market capitalisation: $14 trillion), Japan ($3.5 trillion), and UK ($2 trillion).

However, if the Indian stockmarket has to find a place in the global league, large market capitalisation values alone will not do. Nearly 50 per cent of all US households-directly or indirectly-own equities. They also have an improved understanding of the stockmarkets, thwarting attempts at manipulating prices in the US bourses. In contrast, in India, the bourse is still a relatively-esoteric world, controlled mainly by a cabal of traders. At last count, just 8 per cent of Indian households owned shares. And stockmarket-related scandals are commonplace. More disturbingly, such scandals, as the Great Indian Securities Scam of 1992 demonstrated, happen when the stockmarkets are in the throes of a runaway boom.

For the moment, though, as the bulls on Dalal Street cheerlead the Sensex's rally in unison with their counterparts in New York, London, Tokyo, and everywhere else, such grim thoughts are unlikely to creep up and spoil the party. Ole!