Stock market in India, is once again, very much in the news. On 21st September the sensex again breached the 20000 mark. Early this year, no expert that I know of, predicted that the sensex will cross 20000 in September. However, this has happened. We are just 5% short of the all time high of 21206.7 reached on 10th January 2008. Is this a variant of what Allen Greenspan called ‘irrational exuberance’?
All bull markets are driven by liquidity. The present one is led by liquidity from abroad. FIIs have pumped in $17 billion into India so far this year, $3 billion during the last month alone. What is driving these huge capital inflows? The following facts are significant:
Global economy is not yet out of the woods. Unemployment in the US remaining stubborn at 9.6% indicates a very weak economy and fragile recovery. The Euro Zone, save Germany and France, mired in debt crisis and the consequent austerity measures, is unlikely to recover in the near future. Japan continues to crawl in the deflation-recession vicious cycle.
In sharp contrast to this dismal scenario Developing Asia is in a sweet spot. Particularly in India, prospects for growth and corporate earnings are extremely bright.
This scenario of growth scare in the developed world, growth scarcity in most parts of the world and good growth prospects in India have culminated in focused capital flows pushing up stock prices in India.
The million dollar question is: Is the market overvalued? Will it crash very soon?
In sharp contrast to this dismal scenario Developing Asia is in a sweet spot. Particularly in India, prospects for growth and corporate earnings are extremely bright
A commonly accepted measure of market valuation is the PE ratio. The historical average PE in India during the last 15 years has been around 16. Presently the PE is 23 for the trailing 12 months earnings and 18 for forward (FY 2010-11) earnings. The BSE 500 has a PE of 24.This suggests that the market is richly valued. The PE ratio in other countries is much lower: US (12), Japan (16), Brazil (15) and Russia (9) are much cheaper. There are experts who believe that the India growth story justifies a higher PE relative to peers. I tend to agree. However the problem with high valuations, howsoever justified they may be, is that some unexpected event or shock (external or internal) may send the market reeling. There is not much DFI money left to absorb the shock of big ticket FII selling, if that unfortunately happens. This is the big IF, the India growth story notwithstanding.
The bottom line is:
Yes, there is exuberance in the market. But, it is not yet irrational.
Investors, therefore, should be cautiously optimistic.
The author has more than 3 decades of experience teaching Economics in several colleges and Universities. Presently, he is Investment Strategist at Geojit BNP Paribas Financial Services Ltd.