Could we have a New Year rally? Wednesday’s surprise 539-point rise in the Sensex has certainly raised that hope. The apparent reason was supposedly the finance minister’s comment that gross domestic product growth will be 7.75%. Well, the PM’s economic advisory council had said that quite some time back, with absolutely no effect on the markets. The reasons probably lie elsewhere.

Brokers point out that one reason for the rally lay in the fact that the Indian market had been lagging the others lately. For instance, the Dow Jones Industrial Average is near the year’s highs. In Asia, the Indonesian, Malaysian and Singapore indices are all near their highs for the year. In the last few days, the Indian market had stood out like a sore thumb, while the others made modest gains. That difference is now being made up.

The other reason certainly is short-covering. The Indian market was certainly short in the last few days and a burst of buying probably led the bears to scramble for cover. The result was a very sharp rally, with the Sensex rising by 3.23%. Nowhere else in Asia did we have such a sharp rally, the most among the other indices being a 1.9% gain in the Nikkei.

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Of course, the other option is the traditional year-end/New Year rally that has been missing in Indian markets so far, though it seems to have started in Europe and the US a few days ago. Volumes are low in the holiday season and with liquidity abundant, pushing up stocks is easy. But Ajit Surana, managing director, Dimensional Securities Pvt. Ltd, points out several reasons against a year-end rally in the Indian market this time. One, valuations are high. Two, there are concerns about monetary tightening by the Reserve Bank of India. Three, this time the pre-budget rally too may be in jeopardy because there is a worry that the budget may actually withdraw some of the tax sops doled out this year. And four, mutual funds are seeing redemptions.

This time, any rally will have to battle against all these headwinds. But as the chart shows, traditionally December and January have been good for investors, with positive returns in seven of the last 10 years and negative returns only during the period December 2007 to January 2008, when the market touched an all-time high before plunging.

Graphics by Sandeep Bhatnagar / Mint

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