The question on everyone’s lips today is, what next? How much more will the market go up? It’s the hot topic of conversation, having pushed current political developments, cricket frenzy and the latest Bollywood releases into the background. These are heady days, when talk of market re-rating, FII inflows and market capitalisations is centre-stage.

It reminds me of the period in the US when the Dow moved from 4,000 to 12,000 in one gigantic leap. Sure, there was the Greenspan ‘irrational exuberance’ spoilsport comment, but it was quickly swallowed up by the monster market. Eyeballs, productivity enhancement, the slaying of inflation, global connectivity, etc. were all cited as reasons for the market’s move. Of course, the then market corrected, and has since been range-bound around 10,500 for the past three or four years. The Nasdaq corrected even more, from 5,000 to the current 2,300 or so.

Why am I belabouring this point? Because there are some lessons for us from the Dow saga. The Indian market has moved up disconcertingly in the past few months. But looking at the relative market valuations, it can still be argued that the multiples have not yet got ahead of themselves. The re-rating in the US happened because of fundamental and permanent changes in inflationary expectations in the 90s. This led to lower long-term interest rates, leading to a decline in the equity discount rates. This, in turn, led to higher equity prices.

This change in sentiment happened quite suddenly and was masked by the Internet and telecom booms and better labour productivity. As often happens in such sudden moves (and I’ll take full benefit of hindsight), the market went overboard and then pulled back when the reality of full valuations hit. Then it overcorrected, before settling back to its current levels. It has been at this range now for some time, as it digests the big move and awaits fresh triggers for its next moves.

Now, let’s look at the Indian parallel. India had, so far, been on the fringes of the investing world’s consciousness. This meant the efficiency of world financial markets did not fully apply to India and our relatively better fundamentals vis-a-vis other countries was largely being ignored. However, the sustained 6% growth rate had to tell at some point. When it did, and the investing world suddenly took notice of India, the correction was bound to happen rather quickly. Money flowed into India and all the relative undervaluation, largely irrelevant till now because of India’s niche status, at once became the reason for the market re-rating.

• Till now, India was on the fringes of the investing world’s consciousness
• There are many externalities that might impact the markets in the future

Now the market is at 8,500, having got here in double-quick time. It appe-ars that the wall of money waiting to come into India is still there and nobody is yet suggesting the market is overvalued, particularly in the context of our regional peers. But comments advocating caution have increased and signs of froth are beginning to appear. Penny stocks are back in discussion, anecdotal stories of market man-ipulation are doing the rounds and corporates are beginning to wonder how they will meet market expectations. The markets, as the say, are ‘priced to perfection.’

But, inevitably, perfection is not what we have in India. There are several externalities that might impact the markets in the future. These could be the expectation of continued growth at 6% to 7% every year going forward in the face of a slowing reform process; sustained high oil prices, which at some point have to be passed on to end-consumers, either in the form of higher oil prices, higher fiscal deficits, higher interest rates or a weaker rupee, or a combination of all; political volatility in the face of state elections coming up this year and global disequilibrium caused, for example, by a busting of the US property bubble, and so on.

When such a correction happens, whether it takes place from the current levels or from even higher levels, is anybody’s guess. And when it does happen, as it inevitably must, its size and magnitude will have to be seen. But one thing appears certain—that such a bull run is bound to be followed by a period of hiatus. Of course, the gnarled and burnt old India hands insist they have seen it all before and are waiting for the market to correct. But the wait is getting longer and the train, meanwhile, appears to have left the station!

Source: The Financial Express