Beyond speculation, the common man looks at investments by foreign institutional investors (FIIs). FII investments may have started coming in, but so far they are only making up on what they withdrew last year. But such investments have come from the time the Sensex was at 2,800 points. The reaction has now begun, but no one knows how low the Sensex could dip.

As I pen this column on Thursday morning, I see that one cannot rule out the Sensexretreating to the level of 3,580 points or even 3,510 points, technically. In the immediate horizon, the market can also undergo tremendous distortion due to the mismatch between BSE and NSE trading this week.

Looking beyond, can one say where the Sensex is headed, and is it time to invest. And is it possible to apply more sophisticated analytical tools to figure out what lies ahead? Importing the techniques of operational research to forecast the Sensex's behaviour is tempting. One could build a linear programming model, putting in all the releavant variables and trying to define the synergistic relations between them. But no sooner than you start, you realise that the high level of variability in all the input factors will put forth one answer: high volatility in the year ahead.

In terms of the model, the behaviour of stock markets is based not only on tangible factor inputs but also on behavioural inputs of investor sentiment, perception, greed and fear. Therefore, I could try a simpler bottom-upapproach. I could try and build a model for monitoring and forecasting GDP and the like which, in turn, influence stock prices.

Unfortunately, the short-term forecasting of GDP growth is beset with several problems and therefore such forecasts have only limited value for basing one's investment decisions, seriously. The only certain thing about such forecasts is that the forecasts will not come true. I shall shortly return to the forecast model. Let us take a small but releavant diversion.

I still believe that the GDP will grow only at close to 4.8 per cent. Sinha's figures are based more on hopes of a turnaround in the economy. And what is the basis for Sinha's hopes? Sinha is different. While Manmohan Singh opened the doors to globalisation, albeit with a gross approach, Chidambaram tried the L-curve. Sinha's strategy is different. He has aimed at consolidation and taken care not to rock the boat with further experimentation. His formula is a hybrid one, deriving from the different schools of economicthought.

The central theme appears to be to get breathing time and look for signs of stabilisation. Besides emitting flavours of Amartya Sen's concept of enabling, his budget takes care of the interests of the major stakeholders who can demonstrate their clout.

But all said and done, the budget's orientation is essentially short term. The long-term ones are in agriculture with limited inputs, education, housing, and continuing the efforts to widen the tax base.

And now let me come back to the relation between GDP and stock markets. Sinha has no magic formula to catapult the GDP growth rate to 7-8 per cent. His expectations are modest, but even those may not materialise. It is quite clear, then, that the Sensex will yo-yo between now and next March. And investors might as well understand this clearly. While stock markets will continue to gyrate to the inflow of GDP growth rate data, say on quarterly basis, long-term investors should recognise this for noise and ignore it.

Let me explain. Even in theUK, the Treasury forecasts of GDP growth in the past 10 years had an average error of 1.5 percentage points. You get an idea of the illusory nature of these forecasts when you realise that the average actual growth rate has been around 2 per cent. This is due to the variations in inputs that go into the forecast model.

But if I want to get a better grip on forecasting, I have no choice but to move from linear forecasting models to Edward Lorenz's model of chaos. In this method, you plot a three-dimensional model taking figures relating to the latest reported period, one period earlier and the figure two periods ago. The pattern will then be like the wings of a butterfly. The more the variation in the input variables, the final outcome would be any point in the periphery of the wing of a fluttering butterfly. The final outcome of GDP or for that matter any other output, based on inputs which have a high variation, is like that.

More so will be the behaviour of the Sensex, as the input variance in theIndian economy and investment go up. Consider the inputs. The growth in agriculture, consumer demand, capital investment, FII flows, inflation, interest rates, all have high short-term variability. And now, if the butterfly wing is not frustrating enough, here comes the crunch. Mathematicians have proved that in this model even if there is a small change in the starting assumption, the end result is chaos. A chaos, simply stated, is like a cobweb in three dimension, a cluster in the centre, but many frequent and stray events that take place outside this cluster in several directions. It is like what happens when you hold a basket of dust to the fan.

The chaos theory should indeed fit India very well. The composition of the GDP growth itself is undergoing a change, with the country trying to skip the manufacturing stage and leaping to services in its growth profile. What use is all this analysis to the investor. With such complex and highly unpredictable variables at work, stock markets would see highvolatility in the year ahead. My advice is this. Stick to the core or the centre of the chaos, that will mark the period ahead.

Avoid the periphery. It can easily collapse. Choose your investments only by value and not by speculative value. And invest for long. Recognise peripheral events for what they are. In my view, even mutual funds would be put to test. Believe me, the flapping of a butterfly's wing in China can indeed cause a storm or hurricane in the Americas. That is chaos theory and I think it has proved itself in stock markets. The Indian butterfly can cause thunderstorms on the bourses. Do not underestimate it. But don't let go of opportunities at core moments. Variations could calm down over the next three years and you will not regret having missed the bus.