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The Peg Ratio

It's that time of the year again. End of the year. Having had a rollicking year (or at least past six months), a whole set of foreign institutional investors (FIIs) have got busy counting the spoils of the year. Word is out: some selling has already happened. Further selling could come 'on the peaks' as the Bombay Stock Exchange (BSE) Sensex bobs up every now and then, as it tends to do.

At the time of writing, the so-called 'ceasefire' in Kashmir of November 26 has resulted in a strong bob-up, sending the Sensex back above the psychological level of 5,000. This has brought back some cheer, but without re-flagging off the heady bull run that took the Sensex from 3,000 to 5,000.

India's benchmark index has been trapped in a narrow trading band around 5,000 for quite some weeks now. Just a fortnight before the ceasefire, the Sensex even witnessed a prolonged 'correction', a term used to describe what happens when an index overshoots a level widely thought to be justified. Much attention has been devoted to baseline signals, global misgivings and FII sales since then.

But what should the retail investor make of this state of affairs? And what sort of strategy should he pursue?

FII Facts

First off, to say that FIIs have suddenly turned their back on Indian bourses would be a gross exaggeration. Nothing of the sort has happened. Look at the numbers. Though net FII investment had turned negative (as per figures released by SEBI) for a few days in the middle, there is no evidence that this signifies any change in overall sentiment. The FIIs remain positive, and a broader analysis shows that their total net investment during the month of November (till November 28) was to the tune of around $724 million (Rs 3,300 crore).

Moreover, FIIs rarely if ever act in unison. "Each FII will be trying to maximise profit," says Abhay Aima, Country Head (Equities and Private Banking Group) at HDFC Bank, "and that is why there is huge buying and selling by FIIs on the same day."

Profit can be maximised in several ways. Some FIIs, having achieved their investment targets, must surely have sold shares simply to book profits. Others have different investment horizons, and would like to stay invested. Since the net asset values (NAVs) of their portfolios are calculated on a 'mark to market' basis (which acknowledges gains without the need to have actually sold any shares), FII fund managers can claim fat year-end bonuses without cashing in their chips. "In fact," argues Manish Chokhani, Director, Enam Securities, "some FIIs may actually buy at the end of the year to shore up prices and thereby show a bigger NAV."

That is not to deny that a few FIIs may have pulled out of India as part of a routine strategy to move funds to even more zippier markets across the globe. The 'hot money', as they say, is always chasing the hottest indices, and it's ridiculous to expect the Sensex to retain its sizzle for months on end. It has already been a large beeping dot on the global investment radar for much of the year.

That said, perhaps the most important fact is that no single foreign institutional investor-not Morgan Stanley, not Janus, not even the Singapore government-has sufficient power to 'move the market' anymore. So even if a heavy-hitter decides to do something, the impact on the overall market is likely to be subdued.

The Local Story

That was about FIIs. What about big Indian investors?

Now that's a different story altogether. There is evidence to show that domestic institutional investors have started booking profits. Domestic mutual funds, for example, have withdrawn Rs 633 crore from the equity market over the last three months. This could be attributed to the regular cycle of profit-booking, and you could also assume that they will make a re-entry if they spot fresh bargains (watch those valuations).

That's not all. Local authorities have also been trying to cool off the market. The two main exchanges, National Stock Exchange and BSE, have increased margins for futures and options trading, and the unwinding of positions here has spread to the regular cash market as well. "This may have created short-term pain," says Chokhani, "but is good for the health of the market in the long term." Many analysts agree that it's in everyone's interest to keep the market from frothing over in over-excitement the way it has a few times in the past.

So if the market looks too 'range-bound' for your liking, it may actually be good for your portfolio's health.

Your Own Moves

A lull in a bull run is a good time to sit back, review your options and sharpen your investment strategy. Remember, as an independent investor, you are not constrained by any annual accounting timetables and NAV pressures. As a solo decision-maker without anybody breathing down your neck, you are free to move the way you want, and you could turn that to your advantage.

While it helps to know a few daily details on who's buying and who's selling, we would advise you to stop cluttering your mind with all that. That's for short-term punters, not serious investors. What you need to discern is any shift in overall market sentiment, and that requires you to keep a steady gaze on the big picture.

And that means responding to changes in overall systemic risk, for one. And keeping a keen eye on the economy's fundamental underpinnings, for another. "As the fundamentals are still strong," advises Aima, "the retail investors should use these corrections only to buy more." Indeed, the performance numbers are looking good. As visible from the table (see Booming Quarter, previous page), the aggregate profits of domestically listed companies are zooming. India Inc's aggressive restructuring, with all the pain of cost-cutting and downsizing, seems to have paid off (with some help, of course, from a low-interest rate regime).

To get a picture of the effect those sparkling numbers are having on the stockmarket, try using a few simple technical analysis tools such as moving averages. These tell you the market's underlying trend as smoothened out over longer spans of time (charts of daily Sensex movements are too spiky). What you can see, as of now, is a strong uptrend. The flash indication? Buy. For example, the 10-day moving average for the Sensex is still above the 40-day moving average line. This means that the market's undercurrent is still bullish, on the whole.

Sound Reasoning

Stockmarkets, the past has shown, tend to be economic forerunners. If an economy is expected to rebound tomorrow, the buying happens today. But that doesn't mean there will be selling tomorrow. The buying could very well intensify-on expectations of an even better day-after.

Is something of the sort happening in India? Quite plausibly. Put your ear to the ground, and you might pick up a distant rumble. This fiscal's monsoon has already stirred aggregate demand, and economic growth has already got a boost. A proper all-round economic recovery (the kind we seem to be in for) could result in strong corporate performances more than a year down the line. Another wave of reforms, then, together with any sign of a topline resurgence, could send the market into a frenzy.

Is that beginning to sound like a fantasy? Market analysts don't think so, or at least they're not saying. "Domestic Indian consumption is expected to grow up from $210 billion to $510 billion in the next five years," says Andrew Holland, Chief Administrative Officer, DSP Merrill Lynch.

"The actual story-domestic demand story-will drive the market in 2004," says Chokhani.

The question, then, is mainly one of finding the stocks to bet on. This may not be as difficult as it may seem, despite the rise in prices. What you need to work out is how much you expect companies to grow, if a major economic upturn ensues. "Valuations are still cheap and Sensex is still quoting at a low level (11 times of expected FY 05 earnings)," says Nischal Maheswari, Head (Private Clients), Edelweiss Capital.

But don't get carried away by all that. No forecast is ever guaranteed. So stay tuned. If the expected wave doesn't quite come along, you just might be kicking yourself for believing in fairy tales. But then, nobody ever said investing is easy.