The Sensex made history on Monday, October 11, when it touched a new peaklevel of 5151. It, however, closed above 5000 for only four days and endedthe week at 4884. Over the next two weeks, bear hammering brought the Sensexcrashing down by over 16 per cent to close at 4271 points on Nov.1.

There have been no intrinsic changes to cause such a sharp reversal. Nofresh bad news was available, no disastrous results, no global turmoil, noborder conflicts and no political instability. On the other hand, the creditpolicy was positive. The new government was sticking to its proposed actionplan for invigorating the economy and passing critical pending legislation.

Its tough stand in dealing with the trucker's strike over diesel priceincreases showed unexpected resolve. If we look at fundamentals alone, thecurrent scenario is more optimistic for the stock market than the oneprevailing a month ago. However investors are nervous, concerned andhesitant.

There are various theories being propounded for the market fall. Among themore appealing are the ones relating to foreign institutional investors(FIIs). There has been continued selling pressure by the FIIs over the pastfew months. In August-October, they sold Rs 1,600 crore of equity. Thisfollowed investments of Rs 5,00 crore in the previous Jan-July period. FIIshad made significant profits on their investments in the current year andsome profit booking was to be expected. Further, with all possible good newsalready discounted, the markets lacked a sustainable driver for significantupside till the year-end. It also seems to be a bit of a traditional annualfeature - FIIs also sold in Oct/98.

Combined with the profit booking theory are the Y2K concerns of FII. Theseare impossible to dimension. Fears about Y2K problems are well documented.There is strong possibility of a flight to safety by many fund managers,implying a move out of emerging market equity into US Bonds. While FIIs maynot have a serious concern about India's preparedness, they will remainunsure about redemption pressures and would therefore prefer to be liquid.

IBM has recently stated that it will miss analysts' forecasts during thenext two quarters owing to Y2K related concerns. Earnings of largecompanies, including those in software may be adversely impacted. This hasalso heightened sensitivity among FIIs.

Another theory relates to the large outstanding positions on stock exchangesand the liquidity scenario. Local speculators absorbed FIIs sales, even asthey hoped for the long awaited return of the retail investor. Withsignificant favourable indicators, this was realistic to assume but did notmaterialise.

As such, net long positions at the BSE crossed Rs 3,000 crore and badlarates edged up to over the psychological 2 per cent per month. If we addunofficial rolled over positions at other stock exchanges and through NSE/BSE arbitrage, the total financed amount increases significantly. With FIIscontinuing to press sales, operators were caught unawares. Liquidity in thesystem tightened on account of diversion of money to a few large softwareIPOs and the impact was drastic. A sharp unwinding of positions took placethat further accentuated the downslide.

It is difficult to directly correlate stock prices with the release offundamentally positive news. Thus, it should not be a surprise that themarket fell even as everything was looking optimistic. After all, themarkets shrugged off the conflict with Pakistan and fall of the governmentduring the year in favour of higher and higher valuations. A 15 per centover/under valuation has to be expected and will happen again.

Even after this correction, the market has delivered a whopping 65 per centappreciation over the previous twelve months. The number of frequentlytraded companies has more than doubled to 1800+ from 900 a year ago. This ismirrored in the increase in trading volumes. Combined average daily turnoverof the two main exchanges in October was Rs 6,300 crore compared with Rs2,700 crore in October '98. Mutual funds too are mobilising increasingamounts of money from retail investors, driven partly by the tax concessionsoffered and partly by the optimistic outlook.

Cumulative net investment in the first week of November has been Rs 430crore, of which Rs 350 crore was in the last two sessions. FIIs have broughtback in a single week more than 60 per cent of what they sold in the lastmonth (Net FII divestment in November was Rs7.1bn). Long carried overpositions at the Bombay Stock Exchange have also declined. The introductionof equity derivatives finally looks set to become reality. As such thingsare overall positive. This does not however indicate that the markets areheaded up.

Technical factors may cause the Sensex to decline again to 4200 levels, butthe long-term investor may rest easy. The writer is head treasury marketingwith a leading foreign bank. The views expressed are of his own and notthat of the organisation.