Anybody who's had anything to do with Dalal Street will readily testify to the utter moodiness of its denizens. But even by their standards of unpredictability, the events of the last seven months have been extraordinary. Caught off guard by the surprise win of the Congress in the general elections in May, the stock market panicked when it emerged that the communist parties would have a say in the running of the government. In a matter of days, the bellwether index, the Sensex, lost some 1,000 points (or 18 per cent) and bears stepped in to warn of a major correction. But guess what? Instead of nosediving, the stock market not just pulled back in a month's time, but actually soared. It crossed 5,200 by the first week of August and by November was at 5,700. When BT went to press, the Sensex had crossed the year-beginning level of 6,000 during the Diwali samvat trading (it closed lower, though). Declares d-Street's bull for all seasons, Rakesh Jhunjhunwala: "This is the start of a long-term bull run."

What's got the bulls charging? A mix of factors, most important of which is governance. Quietly but surely, the Congress-led UPA government has proved that it can push through important reforms even in the face of opposition from its own Left allies. Consider, for instance, the finance minister's announcement that foreign banks can acquire 10 per cent stake in Indian banks every year over a period of five years, or the raising of foreign investment limit in domestic airlines from 40 to 49 per cent through the automatic route.

BULLS' FAV FIVE The sectors investors are bullish on.

AUTO OEMs are expected to gain from the growing demand for four- and two-wheelers, while auto components manufacturers are beginning to tap markets outside India. BANKS A hike in interest rates, almost a certainty now, will boost bank earnings. Currently industry valuation does not reflect this. INFRASTRUCTURE Given the government's push in infrastructure, cement and steel companies are bound to benefit. Some construction companies will gain too. IT SERVICES & BPO Although valuations are said to discount much of the growth, some stocks do provide opportunity. The return of George Bush as US President is expected to be positive for the BPO industry. PHARMACEUTICALS Despite the industry's recent setbacks in generics and licensed molecules, it is well placed to ride on the global market's need for low-cost drugs.

Equally importantly for the stock market, the performance of corporate India has been spectacular. For the nine quarters prior to July-September 2004, net profits of 485 companies in a BT sample grew more than 16 per cent quarter-on-quarter. While earnings growth is likely to slow in the quarters ahead, in absolute terms it will rise. Indeed, several analysts that BT spoke to for this story said that the Sensex would be in the 6,300 to 6,500 range by April next year. The more optimistic bulls, however, are talking of the Sensex soaring to 7,000.

But key to the recent boom is the return of foreign institutional investors (FIIs) to Dalal Street. In the last four months, the FIIs have pumped $2,358.4 million, or Rs 10,886.20 crore, into the market. In other words, the FIIs, whose number in India had risen to 623 at last count from 517 in December 2003, have been net investors of more than $32 million (Rs 144 crore) on each of the 75-odd trading days past four months. Needless to say, this money has been a big shot in the arm of the Sensex. Says Andrew Holland, Executive Vice President, DSP Merrill Lynch: "The liquidity coming in from FII inflows has been propping up the market."

A Morgan Stanley report reveals that India has accounted for a fifth of the FII money flowing into the top Asian emerging markets since October 2004. That's no coincidence. The Indian stock market has been outperforming some of its better-know peers. For instance, between mid-August and mid-November this year, the Sensex returned about 15 per cent, as against 13.40 per cent of Korea's Kospi and 10.48 per cent of the Taiwan Weighted Index. If one takes a five-month period (that is, June to October), India's return is even higher at 23 per cent.

What are the sectors that fund managers are bullish on? Hazel McNeilage, Managing Director of Principal Global Investors, Asia, which manages $22 billion (Rs 11,000 crore) in global equity, finds cement and engineering attractive, while Goldman Sachs is keen on it, energy and auto. Says Manish Chokhani, Director, Enam Securities: "Two-tier opportunities are available in, say, technology and pharma, besides which we see potential in banks and oil, where p-ES (price-earnings) are in single digit." Commodities like steel are favourties too, because international prices are robust and there's no let up in demand in sight (See Bulls' Fav Five).

We are monitoring India's progress in reducing the fiscal deficit Hazel McNeilage, Managing Director, Principal Global Investors, Asia

A Boom For Sure?

The big question now is, will the fickle FIIs stay? Many, like Ridham Desai of JM Morgan Stanley, think they will. Desai, for one, speaks from experience. In October, he travelled around Asia talking to investors and found that to them, India seemed an attractive market compared to several others in the world. Some brokerage firms have been busy giving global fund managers a first-hand experience of the buzz about India. Recently, DSP Merrill Lynch took a group of 15 global technology investment managers on a tour of it companies in Bangalore and Hyderabad. Goldman Sachs International, too, flew down to India a group of more than 20 chief investment officers and heads of equity and pension funds from the US, the UK and some other parts of Europe, to get a feel of the market.

Not surprisingly, then, nearly 96 per cent of the respondents to a FICCI survey on capital markets expect to increase their allocation for India in the coming year. Boyer Allen Investment Management, an India-specific fund of $50 million (Rs 225 crore), plans to double its allocation by summer next year. Calpers, the $166-billion (Rs 7,47,000 crore) pension fund giant, entered India only in April, but has invested about $100 million (Rs 450 crore). However, Priya Mathur, Vice Chairperson (Investment Committee Trust), Calpers, refused to say how much more it is likely to get into India in the next few months.

Since the market touched a low of 4,200 it hasn't built a strong base C.K. Narayan, Technical Analyst, ICICI Securities

Still, there are indications that more money may chase a finite set of favourites than newer stocks. At the end of September this year, FIIs collectively owned 21 per cent of the top 50 companies by market cap, having increased their holdings in these companies by 0.6 per cent. In contrast, domestic financial institutions (FIs) did not increase their own stakes, although retail ownership went up marginally. Concentration of investment is bad for the stock market for two reasons. One, it will make a handful of stocks more and more expensive, and two, it will keep the stock market rally from broad-basing itself.

A Morgan Stanley report drives home this growing bias with greater force. The report reveals, for example, that in the last quarter, the top 20 stocks by market cap accounted for 81 per cent of the FII investment, and the top 50 stocks accounted for 94 per cent of their net buying (See FIIs' Top 10). Why don't the FIIs want to invest in mid-cap stocks, where there has been a rally, led largely by domestic FIs and retail investors? Backing them involves a slightly higher risk, and that's something the FIIs seem reluctant to take on. Also, don't forget that this year has seen some much-awaited IPOs (TCS and NTPC were two such) and that may explain the spurt in FII investment.

Technical analysts see an ominous sign in the market's lack of a broad-based rally. Says C.K. Narayan, a technical analyst with ICICI Securities: "Since it touched a low of 4,200 in May 2004, the market hasn't built a strong base, which would have proved a support structure for a big rise." Instead, argues Narayan, the market's trot since has largely been driven by all the FII money coming in. For the rally to build, he adds, the market needs to have built a strong base around the 5,000 mark. "As the sense of complacency increases, people are less ready for a reaction when it happens," warns Narayan. "They won't be able to sell in the slide when it comes because the buyers would have gone."

Then, there are other factors over which investors have no control. Examples: Another flare up in oil prices, hike in interest rates (which could potentially take retail money out of stocks and into deposits) and weaker corporate earnings, signs of which are already visible. Says McNeilage of Principal Global Investors Asia, "The most important factor we are monitoring with respect to India is the progress in reducing fiscal deficit." (The government seems on course to meeting its fiscal deficit target of 4.4 per cent in 2004-05.)

Yet, most marketmen are agreed that there's no going back to the 4,500 level. "Talking of the Sensex at 4,500 would be like living in a fool's paradise," blasts Arun Kejriwal, a Mumbai-based stockbroker. "5,500 on the downside is more a possibility." But where will the Sensex be by April next year? Although it's impossible to predict that with any accuracy, Enam Securities offers two scenarios. The worst scenario assumes a p-e multiple of 12 and earnings growth of 15 per cent, and gets the Sensex at 5,522 points. The best scenario bases its calculations on an earnings growth of 20 per cent and a P-E multiple of 14 to deliver a Sensex that stands tall at 7,000.

Which of the two scenarios may come to pass? Possibly the latter one. For hopes on Dalal Street are high. Says Jhunjhunwala: "After being in a bear phase for nearly 11 years, the new bull phase could prove a long one." But, then, like we said, that's just the hope.