When the markets paused for the first time after it hit the life-time high of 8821, there was an unusual response from the Street. Instead of fretting, investors breathed a sigh of relief that the market took a break after the big rise.

A healthy correction would lend longevity to the rally, felt market experts. But as markets slipped further by more than 1100 points during the last three weeks, the sentiment has changed from one of relief to indifference to caution and now seemingly nervous.

Is the two and a half year bull-run which saw the Sensex tripling dying down? Surely, there is a reason to worry. The truth is that the very factors that set off the stock markets to vertigo - inducing heights are now changing.

Foreign institutional investors who have shown faith in Indian equities are now taking the flight to safety. And it is not just India but other emerging markets too which have suffered losses as foreign investors pull out. India may boast of a spectacular secular growth story in the long run but today's reality is that the country is just as susceptible to the global dynamics as other emerging markets.

Even so, there are no compelling reasons why global investors should favour Indian market while defying others. Facts first. In October alone, FIIs have recorded net sales of Rs 3439 crore (Rs 34.39 billion). On the index and stock futures segment, foreign investors have been net sellers to the tune of Rs 6000 crore (Rs 60 billion), highest this year. This year till date, FII have poured in Rs 33921 crore (Rs 339.21 billion).

The changing dynamics

But why are foreign investors selling? And more importantly, will they continue to sell? The recent selling on the bourses has been a combination of technical factors and some change in market fundamentals. Hopeful dealers attribute it to profit booking. Several hedge funds make pay-outs to investors and charge performance fee towards the end of the year.

Since this can be paid only out of booked profits, they are selling on the bourses to monetise their paper profits. Then again, over the past year the India story has really come into limelight and several new investors have come in paving way for the older ones to exit.

Even when markets were looking stretched, several new funds were busy making purchases in Indian equities, as it became an imperative to have an India strategy.

That kept the stock markets rising and rising. Now even as selling pressure accelerates, new buyers are not pouring in with the same furore.

There is another technical factor too. Several savvy investors were deferring their sales decision despite high valuations in order to avoid taxes. How? The one-year period since the budget proposal regarding the tax free long-term capital gains took effect, was completed last month.

So investors who desired to pull out owing to high valuations were simply postponing their sales in order to earn tax-free profits. That explains a part of the unwinding in the month of October. But these are more technical factors and may be temporary.

The real worry is fears of a sustained rise in interest rates in the US. The US yields have been rising continuously for the past three months and rose to above 4.5 per cent last week. Already inflation in the US is at a 25 year high and the 4.7 per cent rise in the consumer price index is the highest rate of rise since 1991. Analysts are talking about a Fed rate target of close to 5 per cent by March 2006.

If this were to be true, there should be little doubt that money will flow back into the US and out of emerging markets. Sure, there are some who feel that the new breed of hedge funds look for handsome absolute returns and will continue to chase asset classes and markets that promise superior growth. But that is a relatively small portion of the total foreign funds' kitty.

It is not quite the first time that the foreign investors have sold in large quantities since the rally started in 2003. In May 2004, worries about the possible rise in interest rates in the US triggered a major sell off in the emerging markets with the MSCI Emerging Markets Index falling about 8.7 per cent. Back home, the effect was compounded by the defeat of the NDA government and the anti-reform noises made by the Left, which resulted in the Sensex losing 15.83 per cent.

Again, in May this year, stock markets fell on fears that rising oil prices could impede global growth, revaluation of the Reminbi and also the continued rise in Fed Funds rate. But worries were short lived and market gained ground once again. This time the worries seem more real as inflation concerns loom large particularly with high oil prices now believed to have some degree of permanency.

Emerging market meltdown

The nervousness is written all over. All major emerging markets have fallen sharply in October with the China seeing the biggest fall of 11.37 per cent.

However, for global investors the Indian markets have been the biggest drain since the currency has also depreciated sharply during the period. In dollar terms, the MSCI India Index has lost 12.50 per cent the highest in the basket. (See table)

But despite the sharp loss in October, the odds are stacked against India. Valuations in India were higher than most other emerging economies making it relatively unattractive even before the crash. Now, after the sharp fall in regional markets, India continues to be the most expensive.

Based on a trailing price-earnings ratio, India commands an earnings multiple of 15.89 times way ahead of other potent markets like Brazil (9.49), Russia (9.75), Korea (9.31) and the emerging markets average multiple of 11.69.

Not that growth will justify these valuations. Even based on consensus 12-month forward estimates, India tops the pack on valuations. The uncertainty on the currency front is also making foreign investors anxious. Given this scenario, it is difficult to imagine that India would escape the flight of capital this time around.

What does this mean for the Indian market? In April and May 2005 when FIIs were net sellers the market did not tank as much, as mutual funds provided support with net purchases worth nearly Rs 4800 crore (Rs 48 billion). But this time despite the huge purchases by mutual funds this month, the expensive valuations have dragged the index down.

Market experts say that it may not be time to bottom fish yet since the market are still at fair valuation plus something. Slower flows and less margin of safety may mean that investors will have to wait and watch and not jump in yet.

With the markets changing track, The Smart Investor spoke to some leading technical analysts for their take on future market direction, Here's what they had to say:

Milind Karandikar, Neowave analyst

An expected correction of unexpected size began with the Sensex hitting 8,800 mark.  The size of this fall took everyone by surprise, including me.  It has forced the bulls to book heavy losses (especially in the F&O segment) and the analysts to announce the beginning of a bear market.

It all started with the long-term bulls, the FII's, suddenly turning bears. This sudden change of opinion always ends one pattern and begins another.

As per Neowave theory, a trend established for a long time (from May 2003) cannot reverse suddenly unless this entire trend is an expanding formation.

Also by Milind Karandikar: Sensex 18K by 2010! Here's why

Those who wish can invest for two to three month's horizon or simply stay away from market for 6 � 8 months.

Let the bears and the bulls settle their issues before the bulls take full charge again, creating an unprecedented bull run during wave G of the diametric formation.

Deepak Mohoni, managing director, www.trendwatchindia.com

Most global markets had been in a sideways range for about a week, but now all have broken out downwards from their ranges to resume their decline. We too were in a similar sideways range for six sessions, but broke out downwards from the range decisively on Thursday.

The resumption of the decline removes the possibility of an end to the intermediate downtrends, which these markets have been going through for the last few weeks.

The Sensex and the Nifty closed at two-month lows in doing so. The Sensex breached 7,835 to resume its downtrend. The levels to be crossed for an intermediate uptrend have moved up fractionally to 8,126 for the Sensex and 2,460 for the Nifty. The trigger level remains 3,579 for the CNX Midcap.

The Sensex, Nifty and CNX Midcap have been in long-term (major) uptrends since May 17, 2004, making the bull market 17 months old. However, there has been a persistent increase in the number of individual major downtrends recently, and this is a clear bear market threat.

Many mid-caps' major trends had already turned down in September. The market's major trend would turn down (signalling a bear market) if the Sensex were to fall below its last intermediate bottom at 7,537. The figure for the Nifty is 2,300 and that for the NSE Midcap 3,054. All the indices continue to remain in intermediate downtrends, and most global markets are also in one.

Devangshu Dutta, Technical analyst

The current pattern is clearly an intermediate downtrend. It has lasted around three weeks and could last for another two months. Volumes after Diwali tend to be weak because, 1) operators take their annual holiday 2) FII fund managers pull back and book profits with a view to year-ending bonuses. Without high volumes, we can't expect a dramatic recovery.

Retracement time: Let's assume that volumes remain low until January 2006 � there will be no recovery until volumes improve substantially.

*Fibonacci time-calculations suggest a trend-reversal in late December. This could be either a clear reversal of the long-term trend or a turnaround from a major market bottom, followed by a renewed bull run.

Retracement levels: On the downside, Fibonacci retracement calculations suggest that the market may bottom at about 2200 Nifty. This conclusion is reinforced by the value of the 200 DMA, which is 2188 (simple) and 2220 (exponential) and straddles the Fibonacci calculations.

It is also reinforced by a simple trendline projection connecting the bottoms of May 2004 and April 2005 on a weekly chart. This line is running at roughly 30 degrees and it will be somewhere around 2230 in late December - early January. That's where we expect a bottom to this trend.

Assumptions

The above calculations are based on one big assumption: the bull market will remain alive. If the above trendline and the 200 DMA are broken, then there's going to be a new bear market in 2006.

Long-term projections

If the market does turnaround from 2200-odd in January 2006 (or December 2005), then 2006 will see a resumption of a strongly bullish trend. However the market would have to climb past continuous resistance to surmount its all time record of 2669.

We've had 16 bullish months since May 2004 - this is about par in terms of time for an Indian bull market. Prices have moved up 106 per centin those 16 months, which is also reasonable in terms of the normal return from an Indian bull market. A three-month correction that knocks off 18 per cent would also be reasonable and this breather may refresh the bullish sentiment in 2006.

*External link: The Fibonacci Numbers