The Hindu Business Line : Remarkable rally

The retail investor cannot be faulted for wondering if the market was perhaps not over reacting to the sub-prime crisis then and to the rate cut now.

The Wednesday rally in stock prices across the globe is remarkable for the speed with which international investors can tinge their worldview with rosy optimism as easily as blacken it with streaks of extreme pessimism. If less than two months ago, US home loan defaults seemed serious enough to warrant a sharp downward shift in equity values, a correction in the benchmark interest rate by the US monetary authority has made them conclude that not only has the danger passed but also the interest rate adjustment carries with it the seeds of a fresh revival. All this is bound to leave retail investors, who are often mere bystanders, bewildered as they strive to discern a broader market direction.

True, the Federal Reserve’s cut in interest rates should ease the pressure on the US home loan borrowers and, thereby, mitigate the threat of defaults and their adverse consequences for market participants. All the same, retail investors cannot be faulted for wondering if the market was perhaps not over reacting to the crisis in the sub-prime home loan borrowers then and now, to the interest rate correction by the US Fed. Such indeed are the perils of global financial integration.

Pivotal Indian stocks are now valued at an earnings multiple that is close to 22. Any conventional yardstick would suggest that they are over-priced and, hence, some correction is overdue. But against this must be set other mitigating circumstances. A price-earnings multiple of 22 is not something new to the Indian market. The BSE Sensex stocks traded at this level last November when the index closed at 13,696 on the last day of the month. A 20 per cent rise in the Sensex notwithstanding, the earnings ratio is at about the same level. Clearly, corporate earnings have kept pace with investor expectations in the interim. Also, if earlier the rise in equity values was confined to a handful of stocks, that is no longer the case. The present rally is broad-based with even mid-cap and small-cap stocks participating in a large measure; the prospect of a mid-term poll is being dismissed as of no consequence on the premise that the new government may be even more reform-oriented than the present Government that is constrained by the Common Minimum Programme committed with the Left parties, whose support is essential for its survival. The flow of international capital, which sees India as a safe haven for some of its surpluses, is adding momentum to the current rally.

But none of this should be taken to mean that Indian stocks are now correctly priced. Both economic fundamentals and perceptions can change. Volatility is here to stay. The markets are not for the faint-hearted or for those entering with borrowed money.

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