After two years of inaction, investors can finally hope to profit from the stock markets this year. Analysts and fund managers are predicting that this year equities will emerge from the dumps, riding on better corporate profitability and growth.

The benefits of low interest rates will be reflected fully in corporate results this year, and hopefully the absurd disparity between bond and earnings yields will get corrected. However, investors will have to be more responsive to changes as markets will be event- driven.

As always, being in the right sectors will pay off, but picking the right stocks will be even more important. Fund managers endorse the view that the blockbuster themes for this year will be banking, IT-enabled services and public sector companies.

The last two years have seen a divergence in the performance of the equity and debt markets. The continuous cuts in interest rates have led to a spectacular rise in bond prices, giving rise to capital gains for investors in debt.

The fall in rates should also have benefited equities as future earnings streams have to be upvalued, but strangely, this didn't happen.

So we had an incongruous scenario where the debt markets boomed even as equity stagnated.

In the last two months of 2002, however, the stock markets have shown some signs of revival with the Bombay Stock Exchange Sensex rising from a low of 2841 on October 28, 2002, to 3377 on December 31, 2002.

The best part of the rally is that it has been broad-based. Some sectors such as steel and textiles, which had almost been written off by analysts some time ago, have made a comeback.

For sure, fundamentals are supportive. It won't be inappropriate to say that a real recovery may be in the offing.

According to data released by the Central Statistical Organisation, the industrial and services sectors grew by 6.1 per cent and 7.6 per cent, respectively, in the second quarter of fiscal 2003 compared with 2.7 per cent and 6 per cent in the same period last year.

More importantly, the manufacturing sector grew at 6.4 per cent compared with 2.6 per cent last year. Similarly, the Index of Industrial Production has risen from 4.5 per cent in June 2002 to 6.1 per cent in September 2002.

Within this, the manufacturing sector has shown an increase from 4.2 per cent to 7.3 per cent over the same period. This underscores the fact that Indian industry is very much on the road to recovery.

Further proof of the recovery comes from the sales and profit growth figures reported by companies. After showing a decline in the second half of fiscal 2002, the first two quarters of the current fiscal year show an increase in sales figures for the top 183 companies.

An increase in sales is the most powerful indicator of whether companies are poised for growth. Growth in sales, along with a decline in interest costs, has increased net profits this year.

Profits have  increased by 51.23 per cent and sales by 9.50 per cent for the quarter ended September 2002.

For the coming year, market players expect a fairly bullish performance.

Says Rajiv Sampat, director, Parag Parikh Securities: "The market is intrinsically strong and should remain buoyant during the year."

However, the market may also remain focused on particular sectors at any given point of time. Says Vallabh Bhansali, director, Enam Securities: "Market sentiment will favour different sectors at different points of time. The sentiment is positive and the markets should rise over the coming year."

Tridip Pathak, equity fund manager, IDBI Principal Mutual Fund, shares a similar view. "The stock markets should increase across- the-board with some sectors benefiting more than others. The sectors that are cyclical in nature, like steel, should do better," he says.

He is also bullish on IT services and the banking sector.

So what should be your stock strategy this year? The free fall in the markets for the greater part of the last decade has left many investors short-changed.

The fact that the market is at present trading below 1992 index levels means that the average investor would have lost if he had invested in Sensex stocks.

This does not mean investors haven't made money at all. Even though there hasn't been a broad-based rally in the market, a number of stocks have performed exceptionally well during the period.

Some stocks, such as Tata Steel, have done well over the period, despite the fact that the sector has grossly underperformed over the years.

What this means is that in Indian markets, a bottom-up approach is more rewarding as against a top-down approach.

So the trick really is to invest in companies which are fundamentally sound and also have a reliable management.

Says Nikunj Modi, assistant vice-president, Retail Sales, Refco Securities, "While picking stocks, investors must be conscious of the risk associated with a stock."

For instance, the risk associated with a small cap technology stock is far higher than a well established FMCG company.

Also, most retail investors tend to follow a 'buy and hold' strategy. But in a fast changing business environment, it is important for investors to constantly monitor the stocks and the business the company is involved in.

Secondly,  the portfolio should be kept under constant review to ensure that the risk-return profile keeps changing with time, says Bhansali.

Thirdly, investors should make it a point to book profits continually. Investors tend to hold on to their stocks when prices are rising and before they realise it the markets have moved on and profits evaporate.

Says Sampat of Parag Parikh Securities, "Investors should exit the markets as soon as they are able to achieve the desired returns and not wait till the up-move reverses."

Despite all warnings, most retail investors tend to nurse junk stocks in their portfolios. This is basically due to an unwillingness to book an occasional loss.

Says Refco's Modi: "Setting up stop-loss triggers that will give a sell signal if the price falls below a certain level is the best way to avoid junk."

Even then, if investors do get saddled with junk bonds, the best strategy would be to sell stocks as fast as possible and book the losses. Also, it is a good idea to book losses before the year-end as capital losses can be set off against capital gains and investors can at least save on taxes.

Most happening

Though the market rally is expected to be much more broad-based this year, there are some sectors that are likely to grab the limelight.

The first sector that comes to mind when one thinks about market themes for 2003 is public sector stocks. The divestment story has already pushed up the prices of these stocks.

However, in the past few months, a big question-mark has dogged the divestment process with the government dithering over the sale of profitable companies, especially those in the petroleum sector.

If such delays continue, there is the possibility of an erosion in the value of candidates like HPCL, BPCL and Nalco.

But analysts are still optimistic. While movement in these stocks will remain event- driven, they could still be in the limelight because of hefty dividend payouts.

With the fiscal deficit set to touch 6.4 per cent, the government will rely on oil sector companies for handsome dividend payouts.

Karthik Ramakrishnan, Sunidhi Securities, says that this should keep up the values of PSU stocks. All told, there is reason for the investing public to retain its interest in PSU stocks - if it is not the divestment story, it could be dividend payouts. Or both.

Another area where some action could be seen this year is in IT-Enabled services. This sector has seen massive growth in the last two years with several international companies such as efunds International, O2 and EXL setting up shop in India.

Nasscom estimates say that the IT-enabled services industry should touch $17 billion in 2008. It is against this background that some companies are planning to come out with initial public offerings.

The IPOs of Daksh and EXL are awaited this year. Given the growth projections of the industry for the coming years, these two IPOs are likely to be met with enthusiasm.

The third area of focus for the industry is likely to be banking. The banking sector is expected to sustain the growth in profitability this year.

Last year, it was treasury profits from declining interest rates and trading that enabled banks to show huge profits.

Alongside this, there has been a drop in non-performing assets.

Tridip Pathak says that with the improvement in the economy, banks would see an improvement in the credit offtake, which again should improve their income.

Again, the securitisation bill was passed by Parliament late last year. This is expected to give a shot in the arm where gross NPAs are still high at an estimated Rs 70,000 crore (Rs 700 billion).

Besides reducing bad loans, there could also be a small improvement in recoveries. Not surprisingly, the banking industry is widely expected to post improved results over the coming quarters.

This is one reason for the success of recent bank IPOs. Investors in IPOs have already made smart gains on their investments.

Cyclical effect

Since 1988, the Indian stock markets have seen four cycles characterised by an upward movement of prices followed by a drop.

The first cycle had lasted from March 1988 to April1993. The boom trend was seen between March 1988 and March 1992.

The period of recession that followed stretched for 13 months, from March 1992 to April 1993.

The next two recessionary phases (from peaks to lows) lasted 16 months and 14 months respectively. By the turn of the century, however, things had changed. The last cycle stretched from November 1998 to September 2001.

The stock markets had risen between November 1998 and February 2000, when the Sensex rose from 2741 to 6156.  The recession this time lasted a good 19 months between February 2000 and September 2001.

September 2001 is taken to be the real bottom as the markets had closed higher in October 2002. According to Baldev Chawla, this is a bullish signal and indicates that the markets have bottomed out.

What one can see is that the bear phase timeframe has become longer. From 13 months in 1992-93, the period had widened to 19 months in 2000-2001. Analysts say that this is because the Indian stock markets have developed stronger links with the global economy.

This is in contrast to earlier recessions where the government could act to bring the economy out of recession.

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