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Sunil Nayanar | February 02, 2004

If you were an investor with a somewhat weak heart, the equity market would hardly have been the ideal place to be in during the last three weeks.

The Sensex has been on a proverbial roller coaster, with 150-200 points surges and drops being the rule rather than the exception.

This period of extraordinary volatility started in the first week of 2004, with the Sensex crossing the 6,000 mark and touching an all-time high shortly afterwards.

However, the bulls who were laughing all the way to the bank for much of 2003 were caught unawares by an avalanche during the second week.

Even the normally bullish FIIs turned net sellers during the week, as the Sensex lost 173.40 points for the week ended January 16, 2004, and settled below the psychologically important 6,000 mark.

More of the same was to follow the next week as the indices again went on a seesaw, climaxing with the Sensex moving in a 250-point band intra-day on January 23.

The euphoria at the start of the month was fueled by the reform-oriented mini-budget announced by the government and other positive developments.

Among them: Sebi's decisions to cut the derivatives contract size from the current Rs 2 lakh and introduce margin trading/securities lending, the RBI's upward revision of the GDP growth forecast and the start of an upbeat quarterly results season.

But silently, as some of the smarter money started booking profits, negative developments pulled the plug on optimism.

These developments included the closing out of outstanding derivative positions in January contracts and fears about a ban on participatory notes (proved false subsequently).

Sebi's clarifications on PNs, and the foreign currency ratings upgrade by Moody's to Baa3 and Fitch to BB+ didn't entirely dispel the market's fears. The markets rallied only to fall.

So where does this leave investors? Should they be buying or selling? Should they be booking profits or staying put on their investments? To find answers, The Smart Investor spoke to a number of leading market players, including fund managers and analysts, for their assessment of the situation regarding the market's short-term direction, the fundamentals and valuations.

While nearly all of them were positive about the long-term sustainability of the current uptrend, they were not so sure about the short-term. Some even predicted a 10 per cent drop in market returns during the year.

However, they agreed that the fundamentals are still in place, as evidenced by good corporate results and positive economic data.

The consensus: valuations in some stocks are a bit stretched, and some degree of correction is to be expected, but the fundamentals are sound and long-term growth prospects are healthy.

Here's what they said:

Parag Parikh, Chairman, Parag Parikh Financial Advisory Services

Currently there is too much of fear in the markets. People are unable to take decisions since the markets have tended to move up and down in a big way.

However, I would say that as long as there is fear in the markets, the markets will go up. The markets are a little confused at present because of the fear factor.

But I don't think the current volatility signifies a trend reversal. The trend is still positive. The fundamentals are still in place and valuations are not stretched.

Overall, I would say that the markets are looking healthy and the upsides are going to sustain for quite a while.

Raamdeo Agarwal, Managing Director,  Motilal Oswal Securities

I think the current volatility is perfectly normal. The markets are bound to go up and down.

It had gone up nearly 100 per cent last year, and hence periodic selling is bound to take place. So in that sense I don't think there is any trend reversal taking place.

Good corporate earnings are an indication that the fundamentals are still in place. Valuations are also fair at the moment. Investors should look at returns in the band of -10 to +20 per cent during this year.

Abhay Aima, Head of Private Banking, HDFC Bank

I would say that when we talk about volatility you have to see things in perspective. There was practically zero volatility from 3000-6000 levels (for the Sensex).

But from 5,800-6,200 levels it has been extremely volatile. So I would say this is an isolated patch rather than the emergence of a major trend. There will be stages when the markets will be volatile.

Various factors contribute to volatility, like the high run-up in prices, the news flow at a point of time, overbought positions in counters, etc. But these tend to be sporadic in nature and you also have to take into account the current high base.

There is a certain amount of confusion and fear in the markets, but that can be attributed to unaccustomed highs and the crashes that followed previous highs.

As far the current market is concerned, I see it as pretty safe as there is no sign of scam or default on payments. Which are clear signals. The corporate results are also good this quarter.

As far as valuations are concerned, they do appear a little stretched at current levels. But we have to keep in mind that this is the last quarter of 2004 and, looking ahead, I would say that stocks are reasonably valued.

Sanjiv Duggal, Chief Investment Officer, HSBC Mutual Fund

The markets have been on a roller-coaster ride for the past couple of weeks. This is not an ideal situation to have and it has created confusion. This will lead to lot of retail investors opting out - which is not good.

However, the fundamentals are still looking good and our outlook remains positive. Lots of big events are also coming up shortly.

The outcome of the general elections to be held shortly will have an obvious impact on the markets, as will the future pace of policy initiatives.

Valuations look reasonable at present and local and foreign funds are still buying into stocks. The short-term trend is hard to predict, but I feel that the India story is still in place as evidenced by the supportive economic data trends.

R Sukumar, Chief Investment Officer (Equity), Franklin Templeton Investments

From a shorter-term point-of-view, we do expect the markets to be volatile due to the high level of speculative activity.

In fact, this has already led to downward pressure in recent times. We believe that such corrections are inevitable after the sharp run-up witnessed in the latter part of 2003 and this is healthy for the markets.

While it is difficult to predict the level of correction, we shall not be surprised to see the market go down by 10 per cent.

We believe that the coming quarters will be challenging ones for the equity markets with consolidation taking place possibly ahead of the national elections.

The sharp run-up in prices in 2003 has resulted in a correction of gross undervaluations (before that). On a P/E basis, the Indian market no longer looks very cheap. But we feel it is attractively valued for long-term investors considering the strong fundamentals.

Indian companies offer one of the highest spreads between return on capital employed and cost of capital and we feel that this is not fully priced in the markets, which could help sustain the upside over the long term.

Deepak Mohoni, Managing Director,

The abnormal volatility is largely because of structural instability in the derivatives section.

During this period of high volatility, the volume in the derivatives segment rose to about three times that in equities, indicating that most of the trading was leveraged.

This causes a problem, as our contracts are much too large. For instance, a single Telco contract is equivalent to Rs 15 lakh of the underlying share. In the US markets, a Microsoft options contract is equivalent to Rs 1.2 lakh of the underlying.

So, whenever a futures contract is traded on our exchange, far too much money changes hands in a single transaction.

This is more prevalent when the market changes direction, as traders' stops start getting triggered. Also, whenever the market goes up, the contracts become even more expensive, and the market more unstable.

I don't subscribe to the view that the markets are confused. I think it is going through a routine correction, but the moves have been made pointlessly large due to the huge contract sizes.

However, there is some danger of a longer-term trend reversal, and a persistent decline could end the bull market.

The market would already have discounted future earnings, so in that sense the valuations are stretched. However, they can 'stretch' a lot more if the bull market can rediscover its recent upward momentum.

Technical view: We are in an intermediate downtrend (medium-term correction) within a long-term uptrend (bull market). The market will re-enter an intermediate uptrend if the Sensex crosses 6,031.

On the downside, a fall below 5,568 would take the Sensex to a new intermediate downtrend low, and put pressure on the market's long-term trend.

We have already seen several mid-caps' long-term trends turn down when the market fell to 5,568 last week, and a return to that level would start to hit some of the index stocks, thereby increasing the risk of a bear market.

Vijay Bhambwani, Chief Executive,

The current volatility implies a great degree of churning taking place as the indices are in virgin territory and stocks are rapidly changing hands from weaker to stronger hands.

The bulls lack conviction at higher levels and the bears are hesitant to enlarge commitments at lower levels.

Therefore, there is a great degree of churning taking place in a narrow band. High volatility is seeing sharp price swings in a limited range band.

The markets does not seem confused at all. The mandate is clear - bullish. The indices have risen from 2900 and 950 on the Sensex and the Nifty respectively in the last seven months. A 33 per cent correction would mean a 1000-point correction on the Sensex from a 6250 top and a 500-point fall from Nifty 2000 levels.

Only below these levels should a delivery-based investor feel that the uptrend is under threat. In the absolute near term, the rally from the 1500 levels in November 2003 to the 2000 levels in January 2004 should see a 50 per cent correction to 1750 on the Nifty.

That level is where a long-term trendline support also exists. Therefore, the uptrend is still intact and the present nervousness is a short-term news-driven (elections) consolidation phase.

I do not feel the trend has reversed. The intermediate trend would reverse below 1750 and 5500 on the Nifty and the Sensex respectively and the long-term trend would become bearish only below the 1500 and 5000 levels. Therefore the upmove is intact.

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