Mumbai: India’s bellwether stock index, the 30-share Sensex, ended the year on a strong note on Thursday, gaining 120.99 points, or 0.70%, to close at 17,464.81, its highest in 19 months.

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With this, the Sensex extended its gain to 81% in 2009, its best since 1991, helped by a rally set off by the re-election of the ruling United Progressive Alliance (UPA) in May. The stronger-than-foreseen poll victory triggered investor expectations that it would spur Prime Minister Manmohan Singh to introduce measures to boost economic growth.

Strong performance: The Bombay Stock Exchange building in Mumbai. Abhijit Bhatlekar / Mint

The gain makes the Indian market the fifth best performer in the world, behind Sri Lanka, Russia, Indonesia and Brazil.

The Colombo index topped the charts with a 125% return, buoyed by the end of a 30-year civil war. Russia’s Micex (121%) and Brazil’s Bovespa (82.6%) benefited from rallying commodity prices. Expected 7% growth in gross domestic product, or GDP, and heavy Chinese and Indian demand for its resources boosted the Jakarta index by 87%.

India’s GDP is expected to grow 7.75% in FY10, and analysts are bullish on corporate earnings. Firms that recorded dismal earnings in the first two quarters of the year have improved their performance by cutting costs besides managing inventory and working capital better. The fiscal stimulus measures and lower commodity prices also helped improve margins and profitability despite lower sales growth. This will get better, aided by fresh cash flows as many firms have raised money from qualified institutional investors.

Raamdeo Agrawal, managing director, Motilal Oswal Financial Services Ltd, wrote in a recent wealth creation study: “After two years of holiday in FY09 and FY10, we expect Sensex earnings to clock 29% growth in FY11."

The scenario was very different on the last day of 2008 when the Sensex was 9,647, down from 21,207 at the beginning of the year, and still falling with no recovery in sight in the global economy. By March, analysts started seeing the so-called green shoots of revival even as the Sensex plunged to 8,160. No one predicted the V-shaped recovery that the Sensex eventually recorded during the year.

Also See Sensex Swing (Graphic)

From its March low, the Sensex has returned 114%.

Foreign institutional investors, or FIIs, the main drivers of the Indian market, had sold $12.18 billion (Rs56,880 crore) in 2008 as they had to send money to their home markets. But in 2009, they bought at least $17.5 billion worth of Indian equities net of selling, marginally less than $17.78 billion seen in 2007, the highest since 1993 when the country opened its doors to foreign portfolio investment.

Most of the year’s gains came in the second quarter and on 18 May alone, as the Sensex gained 2,110.79 points or 17.34%, celebrating UPA’s return to power without the support of the Left parties, known for their resistance to economic liberalization.

Between January and March, the Sensex remained almost flat as FIIs stayed away. Even the traditional new year allocations from foreign investors did not materialize, and fund flows remained negative in the first quarter.

The sentiment improved in the second quarter, and foreign investors started opening their purse strings, leading to a breathtaking post-election rally. The Sensex gained 49.28%, or 4,785 points, to end at 14,493 on 30 June.

The third and fourth quarters saw the market gain nearly 10% each, as investors who enjoyed the ride continued to book profits and those who missed the rally tried to get in each time the market corrected itself. FIIs began making fresh allocations in March and kept pumping in money through the year.

Gaurav Dua, head of research, Sharekhan Ltd, a Mumbai-based retail brokerage, said investors should continue to stay invested. “While 2008 was one way down and 2009 went the other way, the new year will be more volatile without any clear direction," he said. “Though there is room for large caps to rise, the mid-cap stocks will do better."

The new year may not be as dramatic, said Daljeet Kohli, head of research for the private client group at Emkay Global Financial Services Ltd. “The sentiment is positive. There is no negative news to hurt that. This euphoric sentiment will continue in the new year as well. I think 2010 will be good, but it cannot be as good as 2009. We saw a spectacular rise in 2009, because of the low base."

Agrawal of Motilal Oswal said the highs of 2008 may not be seen in 2010. He said inflation concerns, a strong pipeline of new equity issues and current rich valuations will cap any significant rise. Dilip Bhat, joint managing director, Prabhudas Lilladher Pvt. Ltd, agrees. “Even with the continued fund flows, it will be difficult for the Nifty to go beyond 5,400 levels, for the valuations have become very expensive for Indian markets. Also, the government’s disinvestment drive will suck out Rs25,000-30,000 crore of liquidity," he said. The 50-stock Nifty closed at 5,201 on Thursday, gaining 75.76% in 2009.

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Graphic by Ahmed Raza Khan / Mint

Reuters and Mint’s Ashwin Ramarathinam contributed to this story.