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THE NEW HIGH scaled by equities — with the Nifty crossing its previous all-time peak last Friday — is an occasion to cheer for investors, especially as the valuation levels are not as stretched as they were in the bull markets of 1992, 1994 and 2000. That the rally is not confined to the pivotal stocks is a good augury. But not so the rally in the stocks of companies with dubious credentials that have resurfaced on the BSE's trading list; the redeeming feature, however, is the opportunity for investors to exit from these stocks after being trapped in them for close to eight years.

An encouraging facet is the way the NSE and the BSE have increased their risk containment efforts. With the sea change in the trading and settlement systems after the collapse of 2000 bullish phase, the market is a safer place from a systemic perspective. But there can be no room for complacency, especially in the still nascent derivatives segment, which has seen explosive growth in volumes. From a regulatory perspective, action in this segment as well as the quality of FII flows need to be closely monitored. With declining yields on other investment options, investors need the equity market more than ever, and regulatory efforts must ensure that the positive investment sentiment among small investors is not abused through manipulative trading by vested interests.

This rally has come on the back of strong FII inflows of about $7.5 billion this year. The sheer magnitude of this flow is unprecedented. The large-scale buying and selling that FIIs do now, compared to their role largely as buyers in 1996 when the previous high was touched, has enhanced their role in influencing price trends. FIIs obviously see a big growth story in India; the higher degree of interest shown by a few global bigwigs may probably be of greater long-term significance than the quantum of inflows. Domestic mutual funds have been marginal buyers but their activism in booking profits and paying out hefty dividends has been good for investors.

The key to equities providing steady and respectable returns over the long term lies in keeping India attractive as a `growth' story. Having invested such large sums, FIIs are unlikely to pull out on a massive scale or in a hurry as both these developments can hurt them badly. This provides a cushion against a `downside' risk. The strength and depth in the underlying corporate performance is a source of comfort. But this also imposes a greater degree of responsibility on those at the helm of the economy and the corporate sector to stay on a policy course that would ensure higher growth rates. This is a must as stock prices have now started to factor in the sustainability of growth witnessed over the past 18 months. Retail investors in equities (directly or through mutual funds) have never had it so good. But if valuation levels keep going up on the back of liquidity, prices will, sooner than later, fall out of kilter with underlying fundamentals. A liquidity-driven rally can take this in its stride for a certain length of time, but this would inevitably be followed by prices correcting themselves to levels that are in tune with fundamentals. This is the bottomline that investors should focus on even as they ride the bull market.

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Cheer rally with caution

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