The return of optimism

The bull run on the stock market still has legs

Even six months back, few would have predicted the strong rally in the Indian stock market that has seen the BSE Sensex rise 112 per cent from its low point of March 2009. Analysts in India usually look for the domestic drivers of such dramatic swings (improved corporate performance, sharp industrial recovery, etc). While these are relevant and indeed important, it should not be lost sight of that markets across the globe have recovered from the sharp fall last year that followed the breakout of the global financial crisis; last week the Dow crossed the 10,000 mark. The rebound in markets around the world has been driven primarily by the liquidity that central banks have been pumping into their respective economies. The dollar carry trade, though smaller than its predecessor, the yen carry trade, has played its part as people take advantage of the combined effect of a weakening dollar and low American interest rates to borrow in dollars and put their money in countries and markets with stronger currencies and higher rates. Some of the money has gone into debt, but the generally low interest rates on debt have prompted investors to seek higher returns from equities — especially in emerging markets that are either rapidly growing or have healthy macro-economic indicators. Also, in some countries, the differential between the interest rates on time and demand deposits is at a historical low.

Since the start of 2009, dedicated emerging market equity funds have seen inflows of close to $58 billion, thus reversing last year’s outflow of $49 billion and breaking the 2007 record of $54 billion. The dollar’s weakening trend and evidence that the recovery in key emerging economies is gaining momentum have prompted fund managers to allocate more money for equities in these markets. India, which has among the smallest exposures to the developed world, has received its fair share of equity investments; foreign institutional investors (FIIs) have bought stocks worth around $13.6 billion in 2009 so far. Almost 85 per cent of this money poured in after the results of the general elections were announced in mid-May, with investors convinced that a stronger coalition government would push through more policy reforms than the last government did.

Within the broader global trend, the Indian market has done better than the others. The trigger for this has of course been the revival in the domestic economy. For the stock market, there can be no better news than cars and two-wheelers selling in large numbers, and makers of capital goods seeing bigger orders each day. If there were any lingering doubts, the latest factory output numbers (showing a return to double-digit growth), would have convinced skeptics that the recovery is for real. Also, while many corporate balance sheets were highly leveraged, several companies have managed to raise equity during the past few months so that debt-equity ratios now look more comfortable. Except for rising crude oil prices, there don’t seem to be any spoilers on the horizon and the market appears to be pricing in a V-shaped recovery, convinced that policy makers will hesitate to withdraw the fiscal stimulus for fear that the nascent recovery may get reversed. The big question is whether stock prices have run ahead of fundamentals. India is now more expensive than Brazil, Korea and Hong Kong though it is cheaper than Taiwan and China. However, analysts are likely to upgrade earnings estimates. Earnings for the Sensex set of stocks are expected to grow by 20 per cent in 2010-11, which means that at 17,322, the market trades at 15.6 times forward earnings. That displays optimism but does not seem overly expensive if the assumption is that the economic tempo will continue to gain momentum.