The Hindu calendar year gone by, was easily one of the best experienced in the life of the stock market. Vikram Samvat 2063 saw the stock market grow by nearly 50% and this is quite unprecedented. If one considers the theory that equity markets tend to grow, on an average basis, at the rate of the nominal GDP growth, then considering the fact that nominal GDP growth is around 15%, the Sensex growth is phenomenal. So the question is, will the markets catch up on the law of averages or will it perform the way it has in the past three years, giving above-average returns.

Overall, analysts and fund managers FE Investor spoke to were of the collective opinion that the long-run story is intact and Indian markets will keep growing at an above average growth rate for a few more years. However, not many were ready to state their opinion on the outcome for the year ahead. And that is not without a reason. There are several factors that have literally put the short term direction of the markets at a crossroads, avers a fund manager with an overseas fund.

Flow factor

For starters, there is the question of fund flows. The current run-up, from 18,000 levels, was witnessed purely due to overseas inflows. Funds came gushing in when the Federal Reserve cut rates for the first time. The market, even at the the 18,000 level, was overvalued and the run-up has taken it further deep in the overvalued zone.

With the central bank taking a hawkish stance on controlling inflows, chances of a huge gusher are little. The stock market regulator Sebi?s clampdown on participatory notes will see reduced participation from hedge funds. This seems to be the overall consensus. Hence, an overly ambitious market move over the current level cannot be expected till the first quarter of 2008.

Both overseas and domestic institutions would be closely watching the developments on the political side as well. Elections are due in 2009 and there are signs that the government might want to play to the gallery and dump hard reform issues to the backburner. There is no clear direction here and players keep their fingers crossed.

Fears of a US recession also loom large and there are two views on the set of outcomes. One, which says that a US recession will have a negative impact as the currency would further weaken and hurt exports. The other view holds that a US recession will not have such a large bearing on India as the country is not yet directly linked with the US as others are. And, with the US slowing down, funds would find their way to India. Already, experts reckon that $600 billion worth petro-dollars are likely to be pulled out of the US and find abode in emerging markets.

The dichotomy is also seen in the response to interest rates. If the rates are cut, corporate earnings would flourish and hence the markets. Similarly, if rates are hiked, the differential would attract funds into the Indian market and the rupee would appreciate again. Here, however, corporate earnings would take a hit.

So, while on the one hand current logic suggests that there would not be a sustained rally, there are developments that indicate there could well be one. Like the finance minister said at an event every truism has more than one opposite truism.

Portfolio strategy

This notwithstanding, investors will increasingly find themselves at a crossroads in the coming year. Financial planners therefore suggest the necessity of being fleet footed, by keeping cash and near cash assets available to participate in a new upsurge. The focus, as always, would be on the equity market.

For long term investors, corrections would throw up opportunities to accumulate strong infrastructure companies. Clearly, if the India story has to happen, infrastructure will have to fuel it. Therefore, infrastructure and capacity expansion related sectors, capital goods, real estate, cement, power generation and suppliers to the power sector, are expected to gain. Analysts recommend a continuation of an overweight strategy in these sectors.

Many of the companies in these sectors have strong order book positions and will be able to depict hard core earnings visibility. Fund managers prefer to have companies like BHEL and L&T as these are large players with ample liquidity and strong earnings traction. Companies like Reliance Energy and RNRL, which have run-up strongly, will be watched closely for earnings visibility and project execution. These will always keep providing strong trading opportunities, reckon analysts.

The jack-in-the-box has been the pipes sector. There is huge demand for the pipes used in transportation of oil and gas in the domestic as well as in the foreign market, especially in the US. Also, pipes used in water sewage and drainage can also be considered. There exists a water shortage and lower connectivity in the rural areas. The government has increased the budgetary allocation for giving sanitation facilities in urban and rural areas. And the order books of the players are brimming.

The surprise package this year, on a contrarian view, would come from the fast moving consumer goods (FMCG) sector and even the oil companies, who have been taking a hit due to high oil prices.

?The FMCG stocks will make a comeback. They have earnings sustainability and also were not a part of the recent run-up. They will have to catch up sooner or later,? says Parag Parikh, stock broker, financial planner and author.

Overall, analysts and fund managers also recommend taking exposure to high dividend yield companies in the pharmaceutical sector. The theme would be to hold a good portion in liquid or near liquid assets so as to pick up value opportunities, when they emerge.

Fixed income

Here, the mid-term review of credit policy by the central bank has also indicated that a liquidity oriented portfolio would be beneficial. Its effort to suck out liquidity will mean that liquid assets would be at a premium and therefore fetch stronger returns.

?We have a bias towards stable or lower rates at best,? says K Ramnathan, head fixed income with ING Vysya Asset Management. We believe, there will not be a rate cut in the next one year, he adds. Though there are others who reckon that rates could move southwards.

Either way, opportunities in short-term debt funds could help you build liquidity. If you are keen to look at some short-term instruments and fixed deposits are not making sense, do have a look at short-term bond funds with a time horizon of two to three months.

If you are interested in double-digit returns over the next couple of years with low risk, income funds make a good investment case. Ramnathan believes that fixed income funds will be back with a bang. A grade corporate paper is available at 9.33% and this is a good spread over government paper and also fixed deposits, as they have tax benefits.

On the other hand, if you are willing to take higher risks, you will be better off with long term gilt funds. Long-term government papers are being mopped up by most of the life insurance companies to address their long-term investment needs. Higher demand and higher sensitivity to interest rate changes is expected to reward the investors in the long run.

Alternative sources

And then there are the commodities. Sample this: had you invested a lakh a year ago in lead, your investment would be worth Rs 1.73 lakh today. And then there is the crude factor as well. Threatening to breach the $100 a barrel figure, an investment in crude would have turned your lakh into Rs 1.54 lakh. This is far better than the Sensex as well. Jim Rogers, the global investment guru believes that commodities would far outshine other asset classes (see speech on page 10)

Despite strong show by various commodities, investors in the country continue to predominantly put their money in the stock market and have failed to take advantage of the returns provided by the commodities futures.

Lack of adequate awareness about commodities futures market and more so, about commodities as a reliable asset class among retail investors, seem to be the cause, says Rogers.

UBS, in its recent report released last week, has said that commodities have outperformed all other assets so far this year and their volatility has been much lower. Is it the right time to enter commodities now? It is, say analysts tracking the commodity sector. But they are not sure if the investment would generate the same quantum of return as seen over the last two years.

?Further commodity price gains are likely to be tempered in the near term but the longer-term diversification benefits of commodities should remain intact, because of differing demand, supply, and seasonal factors,? says the UBS report.

Not so strangely, when the dollar is weak, oil prices peak, so do gold prices. While gold prices have been peaking, white precious metals like silver and platinum have been showing a strong trend. While gold is seen as a store of value, silver has more industrial applications and platinum is fast catching up with the fashion world and there has been increasing demand. Here, investors have seen the advent of gold exchange traded funds (ETFs) and these funds, over short time frames, have also outperformed the Sensex.

This investment avenue is getting extremely popular with the investing class as it is extremely liquid and does not require investors to be bothered about safeguarding the yellow metal and also be bothered about its quality. The experts manage all.

Real estate too is looking up and there is a toss-up between investing in land and property directly and investing in already developed property. Ramesh Jogani CEO & MD, IndiaREIT says that investing through real estate funds is a better option as the entire value chain that is available can be tapped. High net worth individuals are taking a strong preference to this avenue. However, this involves a lock-in of a minimum of Rs 25 lakh worth funds for three to four years. Given that funds have been generating returns in excess of 200%, this seems to be a smart avenue as well.

Then there are art investments and investments in antiques. All these markets are set to provide strong alternatives for wealth management. Overall, expecting the Sensex to provide a better return or match it with the current return, could turn out to be a lofty expectation. While the return would be smart, it would be wiser to tread the market with cautious optimism and keep cash ready at hand to get the most. The current year could also be an opportune time, if you have already not, to spread out into some other asset classes as well. The good news is that the spread here will only improve. Happy investing!