When 2008 dawned, financial markets were in a mess — housing prices had collapsed in the US triggering what many feared to be the arrival of worst financial crisis since 1930s, and some of the world’s biggest financial institutions including Citibank and AIG were at the mercy of policy makers for survival.

India, which many thought was de-coupled from the global economy, was also feeling the heat. Foreign Institutional Investors (FIIs) pulled out nearly $12billion from local bourses, erasing nearly 53 per cent from benchmark Sensex.

From irrational exuberance, investor sentiment swung to the other extreme — depths of pessimism.

Capital was scarce for India Inc, their earnings took a beating and export-oriented sectors such as IT (largely dependent on the US economy) and textiles were hit hard. There were job losses all around. One year down the line, world looks a far better place — 2009 was indeed a year that saw a U-turn in fortunes, thanks to multi-billion stimulus package by global economies including the US, Europe and China. G-20 alone committed $1trillion in stimulus.

At the time of writing this article, the benchmark Sensex was hovering near 17,000 — up nearly 76 per cent from last calendar’s close of 9,647.31 — the best year ever for Indian equity markets!

Still, India is only the fourth best performing market in 2009 after Sri Lanka (102.24 per cent), Brazil (82.75 per cent) and Indonesia (85 per cent). China’s Shanghai SE Composite returned nearly 75 per cent this year.

In a poll on 10 brokerages conducted by FC Invest last year, the maximum returns for the Sensex was predicted by Karvy Stock Broking (16,000), followed by Khandwala Securities (15,975) and Angel Broking (15,000-15,500). The poll predicted average returns of 36 per cent for the Sensex. India Infoline was the most cautious, predicting a 2009-end target of 9,500 for Sensex.

So what has changed?

The equity market rebound in India was played out in three phases. Initially led by shoots of recovery in global markets in March, the rally was fuelled mid-year by a P/E re-rating caused by the surprise positive political outcome, say Toral Munshi and Chirag Shah, India equity research analysts at Credit Suisse. “The uptrend continued into the year-end, supported by the earnings upgrade cycle. In retrospect, it turned out to be one of the best equity years ever, with YTD (year-to-date) gains of 75 per cent on the Sensex,” they say, in a note to clients.

Sandip Sabharwal, CEO of portfolio management services at Prabhudas Lilladher, says: “The initial part of the rally got triggered as the markets became heavily oversold and cheapest in history. At that time, most investors realised that the anticipated financial Armageddon has been avoided and as such that triggered the rally.”

The strong fiscal and monetary stimulus provided by governments in a synchronised manner boosted growth prospects globally. FII investments have already crossed $16billion this year. “The upmove in emerging markets has also received a boost by the US dollar carry-trade where extremely low short-term rates in most developed economies are encouraging investors to look at high yielding assets globally,” adds Sabharwal. A major push for the markets came when the general election results gave a clear majority to the UPA, against most analysts’ prediction of an indecisive verdict. Markets cheered with a 20 per cent rise in the next two sessions.

Darshan Desai, co-founder and managing partner at Euromax Capital Group, says the big government spending push played a major role, while at least part of the answer lies in the credit markets. “India's expansion over the past few years was accompanied by a very robust growth in lending,” he points out.

In fact, foreign inflows into India gathered momentum post-elections, leading to a surge in stock prices.

He is, however, cautious on the outlook for the New Year. “I do not at all feel that the worst is behind us. The interest rate hike expected, a dollar rally and other such factors could see us plunge back into the abyss.” Some of the stocks that have given spectacular returns in the year from among BSE100 companies are Jindal Steel (371 per cent return), Tata Motors (346 per cent), Bajaj Auto (342 per cent), Sesa Goa (334 per cent), JSW Steel (326 per cent), Torrent Power (280 per cent), Mahindra & Mahindra (280 per cent), Ashok Leyland (221 per cent) and Sterlite Industries (221 per cent).

Despite the all-round bullish trend in 2009, some stocks underperformed the Sensex by a wide margin. They include Tata Communications (-32 per cent), Reliance Communications (-23 per cent), Glenmark Pharma (-14 per cent), Bharti Airtel (-9 per cent) and MTNL (-7 per cent).

The key question now for equity investors after the euphoric rally in 2009 is whether 2010 will continue to be a year of equities.

“We expect 2010 to be a positive year for Indian equities, driven by improving GDP and earnings growth and supportive government action on the reform front. We expect Q1 to be choppy, with domestic exit of monetary and fiscal stimulus and intermittent concerns on liquidity-driven global asset bubbles weighing on investor sentiment,” according to the Credit Suisse analysts.

The year also had its difficult periods — the drought situation and the Dubai crisis, but the market showed its resilience. The dollar carry-trade, which saw foreign investors borrow the cheap US dollar to buy other assets including stocks in other markets such as India, was another factor that propelled the stock prices.

This dollar carry-trade could also turn out to be a double-edged sword. “I am most worried about reversal or unrevealing of the “dollar carry-trade, which would suddenly descend upon us if the dollar rallies on a sustained basis as for instance if US interest rates climb northwards and quantitative easing ends,” points out Desai of Euromax.

“The other major risk is the state of India's balance sheet, which has high public debt and a large budget deficit by emerging market standards, while the economy has seen rapid loan growth in recent years. If there is one area where India could stumble, probably this is it,” he adds.