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S. Vaidya Nathan

THE bull-run in stock prices continues unabated, and appears to have some steam left. What distinguishes this bullish phase from the ones in 1992, 1994-95 and 1999-2000 is the absence of meaningful corrective phases.

Usually, such a large move in the indices is accompanied by a few corrective phases, consolidation and a fresh run-up. But the flow of liquidity, led by record inflows from foreign institutional investors (FIIs), has been so strong over the past four months that stock prices have moved up in a relentless manner.

The rally has also encompassed a wide swathe of stocks, unlike the earlier ones when the uptrend was focussed on a small set of stocks. If FII flows continue at the record pace of the past four months (the first 17 days of October saw FIIs pump in about $950 million), the market may become unidirectional.

But equally, correction is a must, and would be healthy for investors. The longer the rally continues without corrective phases, the greater the risk and magnitude of a downside. The stepped-up levels of futures and options trading and margin trading enhance this risk.

Even the 17-year long bull market in the US from the early 1980s to 2000 had witnessed quite a few phases of decline. Some lasted a couple of months and were fairly pronounced. There was also the famous (or infamous) 22 per cent one-day crash in September 1987. But the market gained strength from each fall.

Even as the downside risk looms large, the room for optimism for a sharp rebound rests on factors such as likely support from FII flows in the first six months of 2004, and fundamentals, which, despite a few blips, appear to rest on solid ground. Even if FII flows recede to their usual range of about $1-2 billion in 2004, they may be enough to lift stock prices into new terrain.

As far as fundamentals go, the following positives are in place:

For corporates, the benefit of low interest rates and efforts at cost control; the possibility of fiscal incentives in the government to provide a thrust to economic activity in an election year;

The continued strength in international commodity prices;

The spurt in imports this fiscal; emergence of better demand-supply balance;

Continued strength of the rupee and promise of strength in the key housing and auto sectors.

The risks could be possible interest rate spikes, the cloud over the sustainability of recovery in the US economy and any slowdown in economic growth in China, which could affect commodity prices significantly.

Options for investors: Investors who had already had equity exposures at the end of 2002 and those who have entered equities over the first seven months of the year could be sitting on considerable gains. Profit-booking on a part of your holdings — the proportion could vary from 20 per cent to 60 per cent, depending on your risk preference — may be appropriate to lock into the gains.

Any corrective phase could be used to step up exposures. This approach also assumes importance as a higher degree of selectivity, in term of sectors and stocks, may be evident as far as the direction of fund flows go.

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