Bullish on India

But investors must tread carefully in a rising market

The last couple of weeks have confirmed that the stock market moves in stochastic fashion. For weeks, pundits had been saying that stock prices and major indices would be range-bound, with only a minority putting out optimistic forecasts. Now that the market has moved up 10 per cent in a short fortnight, India is among the better performing markets; for emerging markets as a whole, stock prices have moved up by only about 5 per cent through 2010, while prices have dipped in the developed economies (anyone wants to make the de-coupling argument again?). India also happens to be among the more expensive markets, with stock indices now quoting at 21 times earnings for the trailing 12-month period. Among the Bric countries, both Brazil and Russia have price-earnings (P:E) multiples that are in single digits. Even China has more modest valuations, with a P:E multiple that is just short of 18.

If Indian P:E multiples are in a league of their own, and climbing higher, it is because the growth story here has attracted international attention; indeed, the current surge in prices has been driven entirely by the inflow of foreign money, while the domestic mutual funds (run by all the pundits who speak on television) have been pulling money out of the market. The revised conventional wisdom among the same pundits is that prices are now headed further “north”; optimistic forecasts about future corporate profits have made some observers point out that the P:E on 2012 earnings is a modest 14 or 15.

That would more than justify the current price levels for shares, even on the basis of “fundamentals”, and in fact leave some headroom for a further upswing. Indeed, Indian stock market bull runs have usually ended with P:E levels well above what prevails now, so the pundits may well be right. Besides, there is the general expectation that interest rates will rise slightly in the coming weeks and, therefore, bring about a dip in the bond market, thus encouraging punters to look at stocks instead. Nevertheless, since few of the pundits had predicted that the benchmark Sensex would be sniffing at the 20,000 level in the third week of September (a level last seen in early 2008, with the unwinding of the bull run before the global financial crisis), retail investors should be careful about taking any forecasts as gospel. The price movements have been driven mostly by foreign flows, and there is no knowing when such flow-driven trends get reversed.

In tandem with stock prices, both gold and real estate have also tested higher price levels. The gold market, even though influenced by domestic demand, is driven by global price trends, and reflects the uncertainties that hinge on the question of whether the developed economies will dip into a second recession. In contrast, the boom in the real estate market has domestic causes. It would seem that at least some of the money that has been pulled out of mutual funds is finding its way into real estate. This is mostly speculative buying and, therefore, could be seen as the beginning of an asset price bubble.