The Hindu Business Line : The view at 12,000

As the Sensex journeys deeper into the five-digit territory — it crossed the 12,000 mark for the first time on Thursday — the focus is on whether there is `irrational exuberance', a phrase made famous by Mr Alan Greenspan a decade ago. Is there a bubble or is one in the making? Yes, valuations are becoming increasingly stiff, risks are higher for those entering now and return expectations will have to be moderate. But the fact of the matter is that a robust earnings growth, clean-lean-mean balance-sheets, restructuring, acquisitions, the Reserve Bank of India's conservative handling of the economy and the India macro story, have provided an underpinning to the bullish phase. When a gush of liquidity chases an asset class, it is not uncommon for valuation levels to run way ahead of fundamentals. Such bullish phases also tend to be compressed in short time spans, and over the past three years, there have been a few such phases. This trend has been observed in the past in other emerging and developed markets. In such periods, markets tend to price in several future years of earnings.

The rising market depth in terms of institutional investors and stocks has played no mean a role in increasing India's attractiveness especially for global investors for whom the expansion of large-cap stocks is a lure, a stepping-stone into any emerging market. Only when they get comfortable with the large-cap story in a country will they venture into the mid-cap space. This process is under way as Foreign Institutional Investors have warmed up to the promise of superior returns in this space; they have trailed domestic fund houses in this regard, but their interest is likely to keep the mid-cap story buzzing.

Several sectors such as sugar, engineering and construction, textiles, chemicals and steel that were moribund even three years ago have secured a fresh lease of life, adding depth to the market. Providing the right complement is the expanded list of FIIs willing to write out cheques, a superior geographic spread of fund flows and the growing influence of domestic fund houses, especially over the past 15 months. The relatively superior trading and settlement systems have provided day-traders and investors with a degree of comfort not seen in any of the earlier bull runs. Yet valuations may get to a stage where prices move in a narrow band over a protracted period, just as large-cap US stocks have done over the past five years after a blistering 17-year run when price-earnings multiples more than quadrupled to 35. India has still some way to go before it reaches that stage, but for investors, moderating return expectations and adopting a long-term outlook must become the focal point.

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