Devangshu Datta: High on equity

BEATING THE STREET

It's natural that the new highs in equity prices have led to euphoria. While the ruling UPA modestly refuses to directly claim credit, it can be forgiven for hinting the bull run is a vindication of its policies.

Dalal Street analysts are pointing out that the fundamentals are excellent and the FIIs are queueing up to offer bullish sound bites.

All this enthusiasm may be misplaced. Some contrarians say that any stock market trend that hits the non-financial headlines is already in reverse gear. That is, a record high that makes the front page is worth a short and a record low is worth going long.

That is probably an extreme position. In the pre-liberalisation era, it was considered a breach of faith for editors to put anything except politics on the front page. But the media weightage for financial coverage has increased considerably in the past decade. Front page financial coverage is, therefore, no longer as significant an indicator.

My personally preferred front-page indicator remains the work of R K Laxman. He has an uncanny gift of timing that any operator would envy. For decades, Laxman has always managed to produce a stock market-themed cartoon within a couple of sessions of a long-term trend reversal.

In a wider context, the Indian market movement is directly related to a global revival. That's been driven by liquidity caused by a falling dollar and a movement out of US assets.

The "Sage of Omaha", Warren Buffett, recently admitted that he holds a short position on the dollar. In a speech where he referred to the US as "Squanderville", he said that his uneasiness about record US trade and fiscal deficits has spurred him to move large assets overseas for the first time in his 50-year career.

The liquidity has caused a rising trend in global assets and those deficits could cause a global collapse in asset prices if the US economy runs into serious problems as a result of its profligate policy-makers.

Any take on Indian fundamentals has to be underpinned by concerns on that account. Bubbles always deflate and at best, we can hope for a soft landing when it comes.

On a narrower canvas, Indian fundamentals look reasonable rather than great. The cyclical revival of the economy could continue through next year "" if the UPA maintains momentum on policy-makingand follows through on ongoing infrastructure projects.

Tax-reform expectations for Budget 2005-06 and an acceptance of the Lahiri Committee recommendations are built into current projections. But the UPA will continue to contend with idiocy from the Left and Right, corruption within its own ranks and inflation caused by high global crude prices.

By the price-earnings-growth rule of thumb, Indian equities are fairly-priced. The Sensex trades at around 18-19 PE and consensus earnings growth estimates for this 30-stock basket are around 20-25 per cent for 2005-06.

But rising rates are inevitable, and rising input prices have already translated into price hikes for white goods and automobiles. That could damp consumer demand, and lower growth estimates as well as the value-equation. The market may well travel down 10 per cent from these levels rather than go up another 10 per cent.