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S. Vaidya Nathan

Enhanced global linkage was perceived as a threat in the mid 1990s. Now it is viewed as a growth opportunity, especially for the auto component, pharmaceuticals and information technology sectors.

THE bull market of 1994-95 needed just a pinprick in the form of MS Shoes to trigger a crash. How do the risk factors stack up this year?

Commodity prices have been on a steady uptrend, driven by support from China and a few other Asian markets such as Korea and Japan. But the spurt pales in comparison to the trend in 1994-95, when prices of commodities such as steel and paper hit all-time highs. For instance, paper prices now are less than half of the then highs. The bullish phase in this period lasted for less than a year and the subsequent crash landing was hurtful.

Commodity prices do not a pose significant risk for the next two-to-three quarters as the price rise has been more sedate and firm trends in demand appear a distinct prospect, especially if the recovery in the US economy does not lose momentum.

Price earnings multiples are substantially lower than they were at the peak of the bull market of the mid-1990s. PEMs of MNC stocks were over 50 and those of the Indian biggies, comfortably in excess of 25. From 1995-96, PEMs of economically sensitive stocks have been in single-digit terrain.

Only the sharp run-up over the past six months has pushed them to early-teen levels. PEMs of MNC stocks have more than halved. This bull market is only partially stretched in terms of valuation. Specific stocks have upside, especially if the demand for automobiles and commodity prices remains upbeat.

However, a quantum rise in PEMs appears unlikely unless there are large-scale FII inflows, which could then take prices and fundamentals wide apart.

The focus is bound to shift to the potential growth rates in the economy in FY05 and beyond. Barring extraneous shocks, the economy appears well-positioned to retain the growth momentum, at least through the first couple of quarters of FY05.

A good monsoon in 2004 may strengthen rural demand as this years' monsoon has provided a respite from three years of poor purchasing power due to drought and excess stocks. If the economy starts to slip up, it may pose a big risk to the bull market.

An enhanced global linkage through lowering of import tariffs was widely perceived as a major threat in the mid 1990s. Over the past eight years, companies have readied themselves to battle import competition by focusing on cost control, widening their product profiles and improving distribution.

Now the global linkage evokes a positive response as companies in the auto component, information technology and pharmaceutical sectors look to expand their revenue by catering to outsourcing opportunities. This shift in attitude, from threat to an opportunity, towards enhanced global linkage also captures the deft manner in which companies have adjusted to a rapidly changing environment.

The latter includes a 7 per cent appreciation in the rupee vis-à-vis the dollar. Any further sharp appreciation may be a risk to profitability.

Much as the spurt in forex reserves to nearly $100 billion provides a cushion, any further spurt in inflows may have an impact on interest rates. But a hike in the latter is unlikely till next year's general elections are over.

Extraneous factors such as crude prices and global level politico-economic developments can also spike inflation (already at 5.2 per cent) and, perhaps with a time lag, interest rates. This could affect equity valuation. The tightening of interest rates in 1995-96 also led to a shift from equities.

Fixed-income investment options are unlikely to get anywhere near as attractive as they were in the mid-1990s, when they offered double-digit yield. Small savings schemes are set to offer lower rates. Investors may be forced to look at equities to spice up portfolio returns.

But given their unpleasant experiences over the past decade, a massive shift into equities by retail investors is not imminent. At best, a gradual build-up is in prospect. Notably, through the ongoing bullish phase, they have not hesitated to take profits.

If FII flows taper off, it may to lead to range-bound markets with a downside bias. But as FII allocations for 2004 would make their way into equities, there could be support to equity prices, especially if the fundamental outlook remains buoyant.

Having invested vast sums at higher levels, FIIs may also not be inclined to indulge in large-scale profit booking since that could trigger a downside that could nullify most of their gains.

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