Fundamental growth

It is a good sign that the rise of the Sensex above 6000 has been accompanied not by euphoria but by much soul-searching about the pace of the ascent.

The market regulator has responded by hiking margins on loans against shares. Stockbrokers have been advising caution. All this is good news and an indication that market participants have not lost touch with reality.

There are, in fact, several features about this rally that are cause for comfort. The bull run is not unique to the Indian market, but is part of a global upsurge in equities.

Stock markets across the world have been rising on the back of fund flows, and emerging markets, including India, have seen record inflows.

Further, despite the Sensex crossing 6000, its price-earnings ratio one year forward is around 16, which is not expensive.

Luckily for India, the stock market boom has come at a time when the economy is recovering strongly, a fact brought out in the second quarter's GDP growth rate of 8.4 per cent.

With the third and fourth quarters likely to be even better, thanks to the purchasing power released by the good harvests, and with interest rates continuing to be at record lows, the Indian economy appears to be at the 'sweet spot' most conducive to stocks.

Moreover, with India Inc having pruned its flab, operating leverage has increased, with the result that any growth in the topline will have a stronger effect on the bottomline.

Export growth continues to remain strong despite the appreciation of the rupee against the dollar, and the likely recovery in global trade should also help exports.

It also needs to be added that not only has corporate India made huge strides in efficiency, but our markets too have come a long way since the last bull run.

These improvements call for a re-rating of the Indian stock market, and higher allocations to India.

Also, the conditions that led to huge inflows into emerging markets last year, such as very low interest rates in the US, an increased risk appetite, and the reflationary policy of the Federal Reserve, continue to exist.

Finally, we have seen domestic mutual funds turn net buyers in the last two months, an indication that local money is finally flowing into equity funds. If these inflows increase, they could more than make up for any slackening of FII inflows.

What could go wrong? One worry is that the Indian market may soon turn out to be more expensive than other emerging markets, and that could lead to a slowing down of FII inflows.

But a large part of the flows has come from new investors anxious to get a slice of the India story. A slew of initial public offers (IPO) is waiting in the wings, and the excess supply could hit the market.

But if the pricing is right and part of the demand diverted overseas, IPOs could in fact encourage new entrants to the market.

And finally, what if the developed economies start doing well, interest rates go up and the FII money flows back? Well, interest rates have to go up a long way to become attractive, and growth rates in emerging economies like India will continue to be higher than those in the developed world.

In other words, while markets may have gone up too fast, there are plenty of fundamental reasons for the rise.