Picture this scenario: unholy cow is a thriving restaurant in uptown Mumbai, doing a brisk turnover of, say, Rs 25 crore annually. One fine day, the owner walks up to you and offers to sell it to you for Rs 40 crore. You tell him you will think it over. A few days later the owner is back again, this time with an offer of Rs 60 crore. His reason for upping the price is that restaurants serving beef steaks have become the rage with the city's glitterati. You aren't convinced and send him on his way. A few days later the proprietor is once again back at your doorstep, this time with terror and alarm written all over his face. Apparently, a fundamentalist group from a village in northern India has descended on his restaurant, broken a few panes and plates, and threatened to put him out of business for serving beef. Distressed owner feels the end is near for his successful business, and puts a price tag of Rs 15 crore on it. You sniff a bargain here, and tell him it's a deal. The way you look at it is that the fundamentalist louts aren't going to hang around for ever, and once this short-term blip passes, people will once again queue up for beef steak, ensuring the long-term profitability of the restaurant.

No, this story isn't an attempt to convince you about the feasibility of the restaurant business (or the virtues of eating beef). Rather, it's a stab at explaining the way stock markets behave-to be more precise, how the Indian markets are behaving currently, why the indices have been slipping over the past fortnight, why it is no reason to panic, why, in fact, such a fall is healthy, and how you could take advantage of the current dip in stock prices. Since the benchmark index, the Sensex, has crashed by roughly 600 points since its peak of 6,696, the question on thousands of investors' lips is: Is the bull run over? It's not. Sure, there are a few humps to be crossed in the short term, but that doesn't mean that-like the restaurant owner-you should consider cashing your chips. That may mean you are kissing goodbye the prospect of further profits. For, the markets are just correcting themselves, and if you stumble upon many more like our distressed restaurateur in the market offering to sell their stock (at a lower price), just go ahead and pick up the bargains. For, as Motilal Oswal, Chairman and MD, Motilal Oswal Securities, puts it: "Corrections are good for the long-term health of the market. It has to consolidate now before the next bullish phase."

Having said all that, don't expect the indices to start shooting to the skies once you finish reading this piece. A bout of volatility in the short term is on the cards, but the shortest point is that the long-term fundamentals of the India story are still intact, and the Sensex is poised for even higher levels (higher than 6,600) in the not-so-distant future. "The Sensex should move towards the 7,000 levels by November 2005," says Andrew Holland, Chief Administrative Officer and Executive Vice President (Research), DSP Merrill Lynch. "It should reach 7,200 by the year-end," adds Deven Choksey, Managing Director, K.R. Choksey Securities. Here are five reasons why these gentlemen are so bullish, and why it wouldn't hurt you to put on your investing cap (and bull horns).

#1
Valuations are still favourable

"Consumption in India will increase manifold due to demographic changes" Amitabh Chakraborty VP (Private Client Group)/Kotak Securities

The difference between the current Sensex highs and the peaks hit by the benchmark index of the Bombay Stock Exchange (BSE) in 1992 or 2000 is that valuations in those years had soared to astronomical levels. Not so today. Current valuations, of around 13 times projected earnings for the year ended March 2005, are almost comparable with what stocks were valued at in 2002, when the Sensex was hovering in the 3,000 range. To reinforce this point, in 2004 the Sensex moved by only 10 per cent, even as corporate earnings surged by a remarkable 21 per cent.

That valuations are in the healthy zone isn't backed just by historical data. Sure, when you compare India to other emerging Asian markets like Korea, Thailand and the Philippines, you may get the feeling that stock prices are a bit stretched. But then, as Holland of DSP Merrill Lynch says: "You should also note that economic and earnings growth is much quicker in India than in most other emerging markets." The bottom line: If valuations of Indian shares have gone up a few notches, that run-up is pretty much justified. After all, India is the second-fastest growing economy in the world, right?

#2
The breadth of the Indian markets is increasing rapidly

Thanks to the recent IPO boom, we have some extra-large-cap stocks, in the $5-billion (Rs 22,000-crore) range, listed on the stock exchanges. For instance, the number of such companies with a $5 billion-plus market cap has gone up from just four in 2001 to 14 today. Similarly, in the $1-5 billion market cap bracket, the number has more than doubled from 25 to 67 over the same period. Indeed, the listing of large-cap companies like ONGC, TCS and NTPC, to name just three, is increasing the breadth of the market, thereby making the market more attractive for large and long-term investors. What's more, these large listings are yet to get reflected in the global indices (like Morgan Stanley Capital Index) and hence India's current weightage doesn't do justice to its market cap or free float. That is one reason why most FIIs are overweight (compared to these benchmarks) on India now. With more and more mega-size listings expected (Jet, BSNL, possibly Reliance Infocomm, Hutch, Sony Entertainment and Sun TV in the private sector, and possibly Power Grid Corporation and Power Finance Corporation in the public sector), Indian markets can only get broader, providing foreign investors with many more opportunities to park their money. "India is no more a tiny place that global investors can ignore," says Manish Chokhani, Director, Enam Securities.

"The market has to consolidate now before the next bullish phase" Motilal Oswal Chairman and Managing Director/Motilal Oswal Securities

#3
Indians are consuming more, even as businesses look outward for growth

If the Indian economy is, er, shining, it's thanks in a large part to the contribution from industry, much of which is riding on the domestic growth story. "Consumption in India will increase manifold in the years to come due to the demographic changes (the percentage of the youth in the population is increasing)," points out Amitabh Chakraborty, Vice President and Head of Research (Private Client Group), Kotak Securities. What's more, it's not just the metros and mini-metros that are the playing fields for a retail-led boom; the action is trickling into semi-urban centres and smaller towns. What's also encouraging is that even as Indians consume more, domestic companies in sectors like automobiles, textiles, pharmaceuticals and information technology are looking overseas for growth-not just in terms of direct exports, but also by setting up or acquiring capacities in foreign markets. Result? Unlike many emerging markets, the Indian growth story appears to be benefiting from a healthy balance of domestic consumption and export-driven growth, thereby making it less dependent than most on the US. As a result, India is a great opportunity for investors wanting to diversify away from the US economic cycles.

#4
The investment cycle has only just begun

After years of waiting, watching and belt-tightening, Indian companies in various sectors ranging from cement to hotels to commercial vehicles to steel are blueprinting expansion plans, thereby signalling the beginning of a long-term cycle of capital expenditure, which could go on for at least five-seven years. At the same time, infrastructure investments in ports, highways, telecom, oil and gas, and power are picking up steam, propelled in no small measure by a reforms-committed government.

"With the capex cycle, industrial activity will pick up and consumption (both industrial as well as retail) will go up and it is very good for the economy," says Oswal of Motilal Oswal Securities. DSP Merrill Lynch estimates that total investment spend in the country will increase from $120 billion (Rs 5,28,000 crore) in 2004 to $208 billion (Rs 9,15,200 crore) by fiscal 2007. And don't forget that as a consumer benefiting from the housing sector boom-triggered a few years ago by low interest rates and greater affordability-you too will be doing your bit in fuelling economic growth. For, when you buy a house you buy the economy-be it steel, cement, electrical appliances, white goods, furnishings, the works.

#5
Indians are still grossly under-invested in equities

Dalal Street may appear more bustling these days, but that means little if you consider that the overall equity exposure of Indian retail investors is less than 1 per cent of their total investments. Stock market excesses, scams and scandals of the past, coupled with years of stagnation haven't exactly helped in attracting Indians to equity. What also doesn't help matters is that Indian investors typically enter only when they're very sure, which means that the market would have already gained 50 per cent by then, and they begin to dump their portfolio at the slightest provocation, chastened of course by past crashes. "us investors have lived through an 18-year bull market and, therefore, are attuned to buying on dips. Indian investors conversely sell on every rise since they have never seen any sustainable rally due to the excesses of 1992. And that explains why more and more share ownership is moving to foreign hands now," says Chokhani of Enam. Now, however, with other assured return tax-free products drying up (RBI Relief Bonds have gone, and the future of PPF is also under a cloud), Indian investors have no option but to invest in the stock market. Other factors will also contribute in increasing Indian ownership: For instance, with more and more young people getting into the investing class, the risk appetite also will increase. "The young will be ready to take higher risk," says Chakraborty. Other long-term monies, like pension funds, are also expected to enter the stock market soon. If our market holds on to higher levels for a reasonable time-and there's little reason why it won't-a bull market based on Indian public ownership will commence. By then, fears of "hot money" fleeing the country won't count for much, and hopefully Indian investors will be more attuned to corrections than crashes.

-additional reporting by Priyanka Sangani

For A Few Dollars More

How "hot" are the flows from foreign investors? Is the FII tribe a bunch of fair-weather friends who are inclined to cash out when the going's good, leaving the Indian market in the lurch? Even as domestic investors wrestle with such doubts about the apparent fickle punting habits of the pin-striped moneybags, the immediate reason for the ongoing stock market correction may lie someplace else. The fall in the Sensex indeed might have plenty to do with the release of the minutes of the last US Fed meeting, during which it was stated that interest rates were still too low "to keep inflation stable". For good measure, another comment (from Atlanta Fed president Jack Guynn) that the US Fed has never pledged to raise interest rates only at a "measured" pace (which hints at faster rate increases) has also contributed to the FII outflow. To be sure, as the accompanying chart indicates, in the past too sudden movements of US interest rates have invariably rattled the Sensex (as well as most emerging markets). Here's why rising US interest rates can spook the Indian market: A bigger US rate increase now will halt the weakening of the US dollar, at least in the short term. And there are a lot of funds that try to gain from this short- term movements. "Just after the US election, there was a lot of apprehension regarding the dollar due to the twin US deficits (fiscal and trade deficit). And there was near consensus that the dollar will weaken and that explains the huge inflow of money into the Asian market (including India) during November-December," says Andrew Holland of DSP Merrill Lynch. Now, with hints being thrown all around that the dollar could appreciate, FIIs are picking up the cue and heading to the West. Yet, these outflows are little cause for long-term concern, and could in fact be a blessing. "The US interest rate-induced money (out)flows are short term in nature. Corrections like this will throw out the weak and short-term hands from the market and are, therefore, good for the long-term health of the market. This should be used as a buying opportunity," says Manish Chokhani, Director, Enam Securities. So be it.

Relax, It's Just The January Effect

It's a new year ritual that plays out every year: Local operators build up huge positions-these days mostly in the futures and options segment-on the expectation that foreign institutional investors will buy stock like there's no tomorrow, flush as they are with "new year allocations". This results in a massive build-up of outstanding positions in November and December. December 2004 was no exception. As Arvind Shah, Manager, IDBI Capital Markets, points out: "The outstanding position usually starts at around Rs 6,000 crore (at the beginning of a cycle), and climbs up to Rs 12,000 crore before coming down. But by the first week of January, it had already reached a level of Rs 15,000 crore (in any other month it would typically have been around Rs 8,000 crore). It's this rather illogical anticipation that inevitably results in a significant correction in the New Year's first quarter. Sense duly dawns on the operators, who, lacking the staying power, have little option but to sell when the expected provisioning of foreign money doesn't take place. After all, FII allocations happen all year round, and there's no reason on earth why the New Year should be greeted with a heavy shower of greenbacks. The foreign investors for their part have now begun to predict operator behaviour pretty well. "They have started understanding the nitty-gritty of the Indian market mechanism," says Nischal Maheswari, Head of Private Clients, Edelweiss Capital. The FIIs use the correction as an opportunity to mop up relatively cheap stock and make a killing. Maybe you could too.

Hello, Good Buys

If you are as convinced about the sustainability of the bullish trend over the longer term as we are, you should be identifying good buys-stocks that still have value locked in them. Now, BT isn't a tip-sheet by any yardstick, so the best we can do is identify sectors with bright prospects, from which you could pick and choose (the stocks mentioned are only indicative of the market appetite, not recommendations). CEMENT: The infrastructure development story is finally beginning to be scripted, and coupled with the robust demand from the housing sector (on the back of rising incomes), cement is indeed set for boom times. Further consolidation in this hitherto-fragmented industry (witnessed last fortnight when the world's second-largest cement player, Holcim, got a few of its fingers into the ACC pie) will provide an added impetus to this sector. "We are positive on cement and all mainline cement stocks led by ACC (price as on January 20: Rs 341. Price/earnings: 21.2)," says Sandeep Nanda, Head of Research, Sharekhan. Cement prices have risen sharply over the past six months and are expected to sustain adding to the companies' bottom lines. Analysts expect a robust 9 per cent cumulative annual demand growth over the next three years. COMMODITIES: Consumption growth across a range of commodities is expected to gather steam in China and India, as per capita incomes shoot up in these two countries (which account for 40 per cent of the world's population). Prices of metals, petrochemicals and sugar, to name just three, have been surging for some time now. Steel prices have been firm, and are expected to remain that way over the long term. Commodities stocks that look attractive include Tata Steel (Rs 352, 7.1), Sail (Rs 55, 5.2), Hindalco (Rs 1,259, 13.5), and Hindustan Zinc (Rs 141, 12.2). A few words of caution, though: Restrict commodities to a small part of your portfolio since they are inherently volatile in nature, unless of course you can stomach volatility. BANKING: It continues to be a favourite with institutional investors on the back of continued credit demand supported by an increase in capital expenditure and infrastructure outlay. "We are upbeat on the sector on the back of credit growth, both retail and corporate, as well as stringent efforts put in by banks towards improving asset quality," says Ambareesh Baliga, Vice President and Head of Research, Karvy Stock Broking. Banks are clearly in focus as they shed their dependence on treasury income for growth. The demand for consumer credit business remained upbeat. Retail, which contributed 21.5 per cent of the total outstanding loans in the last financial year, still remains the major driver. Another significant driver is the flurry of acquisitions expected in the PSU space. Stocks in focus: HDFC Bank (Rs 511, 23.7), SBI (Rs 576, 7.7), and ICICI Bank (Rs 346, 13.8). ENGINEERING: Engineering sector is a play on economic growth as well as the Indian resurgence in manufacturing outsourcing. Companies like ABB (Rs 930, 29.7), Siemens (Rs 1293, 27.4) and Kirloskar Oil Engines (Rs 415, 10.8) would benefit from the local capital expenditure boom. -Shilpa Nayak

The New FIIs On D-Street Surprisingly, most of them aver they are here for the long term.

FMG Inc. Kahm: Betting on India in the long term Foreign institutional investors (FIIs) are both feared and loved on Mumbai's Dalal Street, home to the stock exchange. Loved because when they come, stocks soar and investors rejoice. Feared because when they do leave, the stock market collapses, smothering in its debris millions of investors. But guess what? The FII investment may gradually be ceasing to be the feared "hot money". Last year, FIIs pumped in an unprecedented $8.5 billion (Rs 37,400 crore) in Indian stocks, sending the bellwether 30-stock Sensex soaring past the 6,600 mark (it's now down to about 6,100 points). A lot of them plan to stay invested in the long term. Better still, a rash of new India-focussed funds is actually looking at mid-cap companies and private equity deals in listed companies (see For A Slice Of The Pie). Gushes Jon Thorn, MD, India Capital Fund (Hong Kong), with $150 million (Rs 660 crore) under management: "India is the best long-term story in the world." FOR A SLICE OF THE PIE Here's a look at what some of the new FII funds plan in India. Matterhorn Group/US Fund size: $100 m by Feb-end 2005 India strategy: With former Morgan Stanley wiz Vinod Sethi as a partner, the fund is sharply focussed on a dozen companies with market cap between $1 million and $1 billion Naissance Capital/Switzerland Fund size: $100 m India strategy: Its Naissance Jaipur fund, to be launched next month, will focus on mid-cap stocks. Naissance's Managing Director is James Breidling Voyager Investment Advisors/US Fund size: $50 million India strategy: It has a private equity investment approach to listed companies that are well positioned to capitalise on the growing economy. Key man: Shiv Puri, its MD FMG Inc./Bermuda Fund size: $15 million India strategy: Being a fund of funds, FMG India Fund has three managers investing long term and four who manage hedge funds. Headed by Johan Kahm, it is focussed on small and large caps EM Capital/US Fund size: Not available India strategy: Its fund is to be launched shortly, but EM Capital is clear on its investment targets: These will be second and third-tier companies. CEO: Seth R. Freeman Monsoon Capital/US Fund size: Not available India strategy: Its Monsoon India Inflection Fund will focus on high-growth, mid-cap companies. In the last two months, Monsoon India Fund has invested in IT services, pharma and capital goods. MD: Gautam Prakash Ever since Goldman Sachs put out its first BRIC report (on Brazil, Russia, India and China) in 2003, India has been taken seriously by investors. The focus is the economy's fundamentals: It's the second-fastest growing big economy, domestic consumption is growing, exports of IT services and manufacturing goods are clipping, competitive labour market is being tapped by companies elsewhere in the world, and the stock market is attractively valued compared to those of the US and Europe. Notes Balanced View, a Balance Equity Broking newsletter: "...Virtually everyone with some risk capital would want to explore (emerging) market(s) through the hedge fund route." India does not allow hedge funds to invest directly in the stock markets (hedge funds are considered risky), but they are allowed to invest via participatory notes (P-notes) and FII sub-accounts, which have zoomed. Last year, SEBI registered 146 new FIIs and 456 new sub-accounts, taking the tally of total FIIs to 648 and that of sub-accounts to more than 1,800. Mid-caps and long-term seem to be new FII buzzwords. Consider Monsoon Capital, a registered FII sub-account with Kotak Mahindra UK. Its Monsoon India Inflection Fund will invest in high-growth mid-caps, also via private equity deals if need be. Says Gautam Prakash, MD, Monsoon Capital: "Since the fund has a two-year lock in period, we are taking long-term bets with a buy-and-hold approach." Even hedge funds like Naissance Capital are bullish on mid-caps. But different FIIs have different strategies. Some want mid-caps, others large caps; some want to invest in IT and pharma, and yet others in automobiles and infrastructure. The good news in all this is that they are looking at India from a long-term perspective. Says Johan Kahm of FMG Inc: "Long term, the Indian market should perform at least three times as well as the western stock markets." Amen. -Roshni Jayakar

It's A Correction, Not A Crash

ICICI Securities' C.K. Narayan: A correction is normal If the sensex slips below 6,000 or even plunges to 5,500, that's the end of the Great Indian Rally, right? Wrong. Just remember, the bull run that's under way has resulted in a gain of some 2,000 points-right from 4,600 to 6,600-and a correction of even a 1,000 points shouldn't get your suspenders in a twist. Just hear out the technical analysts. "It's normal to have a correction of even 50 per cent in an uptrend such as this one," avers C.K. Narayan of ICICI Securities. Hormuz Maloo of Geojit Securities adds: "We are now in an intermediate-term correction." And Mitesh Thacker of Kotak Securities' Private Client Group expects the correction to last for "another three-four weeks". The short point is that the indices can slip further from here, albeit temporarily. If you want to know by exactly how much, Thacker offers that "the first major support will come at a 38.2 per cent retracement level". Duh? Well, that simply means that the Sensex could fall by 38.2 per cent of the previous rally, which works out to the 5,920-5,950 level. Another significant long-term support level is in the 5,500-5,600 range. To put it simply, the markets are correcting themselves. They aren't crashing.