Last year this time, the stock markets were recovering after their vertical fall following a crash - the Sensex had lost almost 3800 points or 30 per cent in just about 30 days.

Market watchers cited May to be a month of mayhem, as such corrections have happened during May even in earlier years. So, when we entered May 2007 with strong market conditions, the question was when the rally would fizzle out and how deep the fall would be.

May is behind us today, and so is June. The Nifty has already crossed its all-time high on June 4, 2007, and is hovering at 4318 points. The Sensex is yet to cross its earlier high, but it is just 73 points short. So far this year, the markets had good news props - highest industrial growth in the country's history and strong GDP data.

Besides, healthy corporate earnings in Q4 FY07 and falling inflation in recent weeks have been supportive triggers despite many concerns for the market to sustain the current rally. But how far will we go from here?

Analysts believes that the structural growth drivers are in place and we should see sustainable growth in the economy over the long-term. There is a strong belief amongst analysts that the stock markets are in a long-term secular bull run, which may last for many years to come.

Says Ajit Dayal, director, Quantum AMC "In India we believe that a return of 15-20 per cent per annum can be expected from the markets over the next 5-10 years. If the GDP is growing at 8-9 per cent per annum and inflation is 5-6 per cent, the nominal rate of growth in corporate earnings should be 13-15 per cent."

A recent report from Morgan Stanley says in its base case analysis that the BSE Sensex (used as a market proxy) could take 11 years to breach 50,000 points from the current level.

If the assumptions are optimistic, it would take under 8 years to reach the same index level. The report considers certain critical success factors and hence the period to reach 50,000 include some obvious ones such as GDP growth, interest rates, the inflation rate and the success of India's infrastructure roll-out.

Thus, in the base case, the implied Sensex gain is 12 per cent, while in the optimistic scenario it would be over 16.5 per cent.

But this movement is not going to be easy. Though the long-term fundamental outlook remains positive, analysts are worried that liquidity will reduce partly due to the ongoing public issue boom or if foreign investors reduce investments, which could have a negative impact.

Any reversal in the global sentiment could potentially lead to a fall as well. Going forward, the consensus is that the movement of the market will be determined by inflation and interest rates, institutional flows, monsoons, currency movement, and last but not the least, the outlook on the first quarter results.

Institutional money flow

Except in the month of March 2007, when FIIs withdrew investments to the extent of Rs 1,082 crore (Rs 10.82 billion), FII flows have been positive this year in all other months. However, investments are slowing down in recent months.

In April 2007, FIIs invested about Rs 6,679 crore (Rs 66.79 billion) followed by Rs 3,959.70 crore (Rs 39.6 billion) in May and Rs 2,084.90 crore (Rs 20.85 billion) in June.

While talking about his experience about how FIIs and hedge funds view on India, Hemendra Aran, CEO, Aranca says, "From what we gather at the Euromoney India conference, everyone remains bullish on India in the long-term. However, not much can be said about the short-term as investors feel that the Indian market is expensive at a forward P/E of around 17-18."

Globally, FIIs and hedge funds view India as a long term growth story especially after the scorching pace of GDP numbers but in the short term, analysts feel factors such as global liquidity, oil prices and interest rates will be playing an increasingly important role on money flowing into and out of India thus causing volatility in the market.

Says Ramesh Damani, member, BSE, "Globally, investors seem to be consolidating, which is in turn, likely to slow down the flow of money into the country."

Interest rates

Whether globally or in India, the rise in interest rates has always been bad news for equity markets.

Globally, there seems to be some consensus that the European Central Bank, as well as central banks in Japan, China and the UK, may hike the interest rates this year.

It is a positive for the stock market that the US Federal Reserve did not increase interest rates last week. If interest rates start hardening in some of these countries, the impact will be felt in India too as investors will change their risk and return matrix and cut down their leveraged positions.

For domestic interest rates, analysts are increasingly of the view that interest rates have peaked thanks to falling inflation and slowing credit growth.

But they also believe that only in August-September will it be clear whether the current falling inflation trend is sustainable and whether the RBI has stopped, or merely paused, its interest rate hikes.

Crude oil prices have declined to $67.77 a barrel on June 26 compared to $69.14 on June 22 as strike tensions in Nigeria abated.

According to reports, despite a recent decline, oil prices are expected to hover around $66 a barrel in the coming weeks with an upside risk given the global supply constraints and US refinery problems.

The rising domestic interest rates have already hampered many sectors such as automobile, banks and real estate.

The next round of impact could be on the other sectors related to domestic consumption and on incremental consumer demand. A further hike in interest rates will taper consumer demand and thus corporate earnings.

"Though inflation is under control, we cannot rule out the possibility of a small hike in interest rates to sterilise the liquidity from the system in the short term. However, over the long-run we expect interest rates to remain steady at current levels," says Devendra Nevgi, CEO & CIO, Quantum AMC.

Currency impact

The movement of the rupee against the dollar is equally important for the market in the short-term.

On the one hand it will impact institutional money coming into India, while on the other hand companies and sectors which are heavily dependent on the export market will be hit on earnings and this won't be positive for the market.

This is evident from the fact that most companies in sectors like IT, diamonds and jewellery, oil drilling, textiles, and trading have recently under-performed the market due to a rising rupee against the dollar.

In the March-June 2007 period, the rupee appreciated nearly 9 per cent against the dollar, as compared to an appreciation of about 4 per cent over the preceding two quarters put together.

While commenting on the rupee dollar equation in the long run Damani says, "At present, the rupee is in a bull market, and is likely to enjoy major gains over the next two-three years."

Going forward, industry experts and analysts believe that exports of processed foods, agricultural items, electronics, electrical and steel products may fall by 20 per cent.

Moreover, the hardest hit will be those sectors and companies with thin margins. In case of IT companies, their margins will decline by about 30-50 basis points for an appreciation of 100 basis point in the rupee.

Corporate earnings

After considering the impact of interest rates, inflation, currency appreciation, rising oil prices and higher base of the previous year, analysts have already started factoring in some slowdown in Q1 FY08 earnings.

"The results season is closing in, and the focus would be on technology stocks, following the rise in the rupee. Growth in earnings should remain strong across sectors, however, leaving aside interest rate and currency sensitive sectors," says Andrew Holland, EVP, DSP Merill Lynch.

Corporate results in the coming months will determine the further course of the market. Analysts estimate corporate India's top line to grow at about 15-20 per cent in Q1 FY08. If advance tax numbers for this quarter are to be a leading indicator, there should be a decent rise in profitability too.

Advance tax collections for the April-June period witnessed a growth of 28.8 per cent at Rs 13,796 crore (Rs 137.96 billion). This indicates that these companies are well on the growth track and that investors can expect a good Q1 FY08.

Besides, the other big positive could be the distribution of monsoon, which may boost the demand for FMCG, consumer durables and agriculture-related products, and thus improve the overall market sentiments.

Outlook

Unlike in the past, we have reached a stage where investors need to be realistic in terms of their expectations of equity returns. The returns that we have seen in the past three years will only be a memory.

Given the influence of the domestic and international factors, the markets will continue to be volatile in the short run. However, analysts also say, any sharp fall in the market can be used as an entry for the long-term investor.

A portfolio of fundamentally strong companies in sectors that have a large role to play in India's growth story will be the key to successful investing. Fund managers and analysts name some of these sectors as infrastructure, capital goods, power, financial services, telecom and media and entertainment.

Besides, for generating higher portfolio returns, investors can use market volatility to enter into some of the good mid-cap companies with sound business prospects and good financial performance.