In the past one month, the equity markets have started buzzing again. And it?s not just India but even the overseas markets have rallied strongly and suggestions of a revival in the fortunes have started floating around. After all, a 11.32% gain in the 30 share Sensex in April till date after being hit hard in the whole of 2008 is a refreshing change.

So does this mean that the tide has turned and the time to revisit equities is back? Especially since the meteorological department has also indicated average monsoons this year as well. Experts seem to have diverse views on this.

Risk aversion

Overall, there has been a marked improvement in the sentiment, especially by overseas investors. They have been net investors to the tune of Rs 2,956.50 crore in the month of April till date and the mutual funds have net purchased equities worth Rs 519 crore. This is the sharpest bear rally of the last two decades in the last one month, notes Enam Securities in its weekly report. ?As the pitch ? black became a shade less, FIIs got in first, with cash ? loaded domestic MFs and insurance following swiftly,? it notes.

And, observations from overseas also indicate an improvement in the risk taking appetite. Matt Robinson, economist with Moody?s Economy.com notes, ?Despite the on-going stream of poor economic data, the stock market rally has been fuelled by improving sentiment among international investors that the downturn is near its ebb, and demonstrating an increasing appetite for riskier assets such as equities.?

?This is the fifth week in a row we?ve seen this combination of positive net flows into funds dedicated to emerging markets equity and the riskiest kind of bonds,? noted EPFR Global managing director Brad Durham. The firm tracks fund flows into global markets. ?You have to think that all this liquidity being pumped in by central banks around the world is finally removing some of the shackles,? Durham adds.

The results from leading banks in the US also added to the cheer encouraging investors to take more exposure to equities.

Indian uncertainties

However, in the Indian context, there are several uncertainties looming large, the fate of the elections and the formation of a new government being the biggest uncertainty. The current slowdown and the following stimulus package are likely to dent the fiscal deficit and imply stricter government finances. In this scenario, elections get importance.

?The best chance for India to partly overcome the impact of the global slowdown is that the government boosts infrastructure spending. Add to this the bad fiscal situation. This makes funding of a spending programme using public debt very difficult and hence as a corollary, the government will need to privatise assets or raise multi-lateral agency loans. The next general elections become unduly important for the market,? say Ridham Desai and Sheela Rathi of Morgan Stanley.

Historically, the markets have been positive in the run up to the elections but turn nervous as we near the actual counting (typically the elections run for three to four weeks and counting starts after all elections are completed.) ?In fact, in three of the past four elections, markets have given a negative return a month before the result announcement,? says a Bank of America Merill Lynch report on the elections and the outcomes.

?We believe this year the markets are starting with an expectation of a hung Parliament. We are, therefore, looking at a downtrend in the market ahead of the counting on May 16. We think the nervousness will continue till we get a stable government. Post-election, near-term movement of the market tends to react to the nature and shape of the government. The market reacted negatively to a Third Front Government in 1996 and to the Left support for the government in 2004 ? on both occasions the market was lower three months post the result announcement,? the report adds.

Stay defensive

The overall mantra is therefore to stay defensive. And, most of the brokerage houses have been recommending a defensive posture at the moment. An Eanm Securities report actually recommends investors to cash on into this rally. ?While most people already think the electoral results could be eye-watering for India, markets could trough again during or immediately after elections when the labour-pains of actual government formation kick in. Hence, we recommend profit-taking during this manna rally, for a better time to make informed investments then.?

Morgan Stanley analyst also voices a similar concern. ?Our approach is to wait for the outcome before we reduce defensiveness in our portfolio. The reason is that the probability of downside and extent of such a downside appears to be outweighing the probability of upside and the extent of the upside (put together, of course).?

While remaining defensive, analysts have also been targeting companies that would do well despite the electoral outcome. ?We would be defensive (buy Hero Honda, Bharti) in the run-up to elections. We think infrastructure would be a priority for all governments ? Jaiprakash could be a gainer in the post-election scenario,? says a Bank of America Merrill Lynch assessment of the elections.

They also think that a Congress or BJP government without the Left could lead to reforms in privatisation and oil reforms and the gainers would be oil marketing companies like HPCL and BPCL. Banking sector reforms would also make government banks an attractive proposition.

Kotak Institutional Equities? analysts and strategists think that the market is correctly valued at the moment and that there could be a marginal downside as well. Their report says, ?Our bottom-up fair valuation for the market of 11,000 (based on individual target prices of underlying stocks) suggests marginal downside for the market. We note that many of the heavyweight stocks are trading above our fair valuation with only banks and selective commodity stocks offering a moderate upside to our fair valuations for those stocks.?

At the same time, there are some who would want to take this opportunity to pick up bargains. ?There are more than trillion dollars waiting to be invested in the global equities market and much of it will find its way into India regardless of the electoral result, as any political party will not risk downplaying growth,? says a fund manager with a multinational firm. And this makes it worthwhile to invest in India at the moment, he adds.

With this view, Suresh A Mahadevan of UBS said, ?We believe Indian stocks are undervalued currently and our March 2010 Sensex target is 13,500. We have also recently released our India model portfolio. Our view is that the Indian economy and corporate earnings are likely to bottom out in first half of the fiscal year 2010 and the recovery is likely to start from second half of fiscal year 2010 onwards with full recovery in FY11.?

He also adds, ?With this view in mind, we are overweight on autos, banks and metals, as we believe these sectors are the best positioned to play the cyclical recovery. We are underweight on consumer staples, IT services, and oil and gas.? The market has already factoring in the likelihood of Third Front government, they add.

However, as the election results start pouring in, the volatility in the market is expected to pick up significantly. Already the India VIX or the volatility index that measures expectations of volatility in the markets has risen and is now in the 50% mark after being between 30% and 40% for a long time, indicating that from here on the falls in the market could be extremely pronounced.

Savvy investors would therefore require to be extremely alert in these times and avoid looking at new ideas. The tested companies with potential would be available at steep discounts and bargains. Systematic investment in selected equities would therefore be quite what the doctor prescribed. And, bear in mind that the bear rally would certainly throw up opportunities for the long run.