Why Booming Indian Equities Will Rock in December

India's stock market has brushed aside the country's weak economic health this year and soared some 20 percent on the back of strong buying by foreign institutional investors. And investment strategists are betting on further gains for the benchmark Bombay Sensex, particularly in the month of December.

Why Booming Indian Equities Will Rock in December
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Since 1980, December has produced an average return of 4.6 percent, the best for any month in the year, according to Morgan Stanley.

"The December phenomenon is explained by the fall in institutional activity, associated with the holiday season. Consequently, local speculators tend to exert higher influence on shares and they rise in anticipation of fresh FII allocations in January," the bank's India managing director, Ridham Desai, wrote, referring to foreign institutional investor inflows.

Over the past 20 years, 1994, 2000, 2001 and 2011 are the only four occasions when December generated negative returns, he said, adding that there has not been a common cause for the poor returns in these cases.

This year, Desai said, one of the biggest risks for the market includes the parliament session, which could damage the policy environment.

The ruling Congress-led government is expected to legislate around 25 bills including the liberalization of the insurance and pension sectors during the month-long winter parliament session that began last week. However, the new parliament session got off to a rocky start with opposition parties questioning the government over recent economic policies, which could derail its reform agenda.

However, Desai added, "expectations are low, so an upside surprise is more likely."

Top Pick for 2013

Despite the growth slowdown, investors began increasing their exposure to the country's stocks in mid-2012 because of compelling valuations and falling oil prices, which helps reduce the country's current account deficit, and ease inflation pressures.

JPMorgan's chief Asian & emerging markets equity strategist, Adrian Mowat, said India was his top pick for 2013 of the BRIC countries, made up of Brazil, Russia, India and China.

"India, which has had a reasonably good year so far, remains the big market to stick with into 2013. You're coming off the weakest economic growth since we've seen since 2003. We've got a very competitive currency," Mowat told CNBC.

The weakening of the Indian rupee, which has depreciated 3.5 percent against the U.S. dollar in the last month, has been beneficial for exporters as it makes their products more competitive on the global market.

While India's economy has slowed sharply in 2012, with gross domestic product (GDP) averaging 5.4 percent gross in the first half, growth is expected to pick up pace next year, driven by the positive effects of policy reforms and an increase in agricultural output growth.

(Read more: Is the Worst Over for India's Economy?)

"The new Finance Minister, P Chidambaram is very keen to promote reforms, and Manmohan Singh's term as prime minister will be over within the next 12 months, and I think he wants to go out with the reputation of generating some sort of reform. We would describe the Congress party as now managing the economy, rather than simply managing a coalition," he said.

In addition, he said funding costs for Indian corporates is set to decline over the next twelve months, as demand for emerging market debt increases. "You've got a nice economic momentum and companies that have been delivering profits," he said.

While the market has rallied this year, valuations continue to look attractive on a historical basis, Mowat said. The Sensex trades at 15.6 times estimated earnings, compared with 11.6 for Brazil's Bovespa, 9.6 for China's Shanghai Composite and 5.5 for Russia's Micex, according to Reuters.

"What investors like to buy is domestic demand plays. If you buy domestic demand plays in China you are paying 19 times earnings, in India you're paying 15 times," Mowat added.

By CNBC's Ansuya Harjani