Eye On The Market: Market springs a surprise ::Business Line,

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Before you could say ‘bull', this particular stock market rebound has taken the Sensex up 18 per cent and the broader market BSE 500 up by 22 per cent. About twenty stocks listed on the NSE have, in fact, already doubled from their values on New Year's eve.

It is not just the quantum of gains that stocks have made in this two-month period that should surprise investors. It is also the identity of these stocks. Running down the list of top gainers, one finds stocks from sectors such as power generation, realty and infrastructure.

These were precisely the stocks that investors took great pleasure in thrashing to pulp last year on worries about high debt, a sluggish capex cycle and governance issues.

DRIVING HOME LESSONS

This rally has clearly caught market commentators by surprise too. Scrolling through some of their recent advice to investors, we find some of them asking investors to ‘go long' on previously shunned names in capital goods and infrastructure due to ‘attractive valuations'. Others gloomily intone that this is just a ‘dead cat bounce' (to put it more elegantly — a final stand by markets), before the global economy falls to pieces and a real bear market materialises. They are asking investors to sell ‘into the rally' and get out of stocks while the going is good.

Now, whom should you listen to? Preferably no one. For the recent stock market rally just drives home the lessons we have already learnt in 2008-09.

LIQUIDITY CALLS THE SHOTS

One, no one can accurately call turning points in the Indian market because this depends on the direction of FII (Foreign Institutional Investor) flows. Most market watchers did not predict a great start to 2012 because the picture on liquidity appeared quite bleak at that time. But what has lent this stock market rally wings is the fact that FIIs, completely reversing gear from last year, have poured $4.8 billion into the cash market in the first two months of 2012. This is after pulling out some $350 million last year.

Global market watchers now explain this in terms of risk appetite returning, the US Fed's decision to inject fresh liquidity into the system and optimism about a solution to the Greek crisis. Given that no one seems to have great predictive ability about the market, holding back equity investments in the hope of catching a market bottom appears to be a futile exercise.

Two, once a market rally begins, it acquires its own momentum. Though the initial rise may be fuelled by transitory factors such as short covering in badly beaten stocks, this can swiftly transform into a real bull market. especially if long-term investors jump on to the bandwagon and bid up prices further. In fact, the action over the past five years suggests that the multi-year range-bound market that many people talk of as a possibility for India may never materialise, with huge liquidity flows driving stock prices alternately up and down.

Investors looking to make long-term investments, therefore, need to act swiftly whenever they perceive a window of opportunity in terms of low market valuations.

ANTICIPATING FUNDAMENTALS?

Three, valuations of stocks or sectors may move up ahead of fundamentals. Looking at the many indicators of macro or corporate performance today, there are no clear signs of a recovery in the domestic economy or markets.

A few monthly indicators show a pick-up — cement despatches, auto sales, consumer goods production, but others (order flows, steel output) show no material improvement. Inflation is down but the RBI is displaying no urgency to begin trimming interest rates. Profits of Indian companies in the December quarter show no let-up from cost pressures either.

But all this is not to say that investors should hastily cash out of quality stocks after the recent gains. If there is anything at all that we have learnt from the previous bull market, it is that stocks of companies are often re-rated ahead of an actual improvement in fundamentals or profits.

Weighing all these factors, therefore, we wouldn't like to make any long-term predictions on whether this particular stock market recovery will continue or fizzle out.

But if you are a long-term investor in equity, we do know you shouldn't pay heed to the advice that is intended for short-term traders. Hold on to the equity in your portfolio and invest in quality stocks or funds in a phased manner. More on this subject next week.