Nervous Sensex

Those wondering whether the stock market has ended its three-month bull run, and whether it has entered a new, more nervous phase, could focus some of their attention on what has been happening in other Asian stock markets""where values have fallen by at least as much in recent days. The Sensex has fallen by a little over 4 per cent from its peak of 9,648 on January 4. In comparison, the Nikkei in Japan has lost about 4 per cent in just two sessions, while the Hang Seng, after rallying by some 900 points in the first two weeks of the year, has fallen by 300 points this week, or close to 2 per cent. The real question, therefore, is what lies in store for Asian markets as a whole. Indeed, it might be argued that the Indian market has shown greater resilience""repeating so far this year the story of 2000. Considering that there has been a 20 per cent rise in the Sensex, from its October low of 7,686, some amount of value correction is only natural. The issue is whether this is a small correction, or the mark of a new bearish trend. The answer will depend largely on what happens in other Asian markets, and what foreign institutional investors (FIIs) will do. On the evidence so far, it looks more like a correction, and not the start of a bear market.

FII flows, which more or less determine the market trend, show a clear picture. Inflows in January so far have been on the low side, at about Rs 1,600 crore, compared with Rs 4,450 crore in November and Rs 9,600 crore in December (including money received for the ICICI Bank issue). October, when the market fell, had by way of contrast seen a net outflow of Rs 3,806 crore. The good news is that a fairly large proportion of the $10 billion that came in last year comprises India-dedicated money, like the $750 million Merrill Lynch fund floated in Japan. This money will stay invested""at worst, fund managers will sit on a little more cash. However, should there be a significant level of outflows, it is hard to see the market being propped up by Indian investors, who came late into the market and who missed most of the 2005 party.

Meanwhile, the flow of initial third quarter corporate results has shown the slowdown in profit growth that was widely expected, with a squeeze on operating margins on account of rising raw material costs. Some companies continue to do well: Bajaj Auto has even notched up higher operating margins, while HDFC Bank has grown its assets by a strong 45 per cent. The tech trio too has done reasonably well, especially Wipro which beat its guidance. But there is little doubt that the sharp profit surges of previous quarters will not be repeated. It is still early days, though, and the coming three weeks will make clear whether the slowdown in profit growth is spread across the corporate sector. The question is whether, with profit growth of between 15 per cent and 20 per cent, the Indian market is over-valued at a price-earning ratio, prospectively on FY07 earnings, of about 16.