The good times at Indian stock exchanges appear to be here to stay. Fair valuations, impressive growth of Indian companies and continued inflow of FII funds will ensure that

Around 11.09 a.m. on the morning of Monday, June 27, 2005, the Sensex crossed 7,200 for the first time in its life. The number is significant because it is the next big resistance band for the index. Surprised that the Sensex has gotten so high, so fast? Well, you are in good company. Most analysts, brokers and just about anyone else associated with the stock market is as well. "We are not surprised at the current levels," says Manish Shah, Head (Equities and Derivatives), Motilal Oswal Securities. "Only at the speed (at which the Sensex has reached here)." That isn't surprising: the Mumbai-based brokerage has put down its official target for the Sensex at 7,600 by March 2006.

If the script is playing itself out ahead of schedule, blame the foreign hand: Foreign institutional investors (FIIs) are back. In the first 24 days of June, FIIs pumped $870 million (Rs 3,828 crore) into Indian equities. That's in sharp contrast to their behaviour in April (when they withdrew $150 million, Rs 660 crore) and May (when they withdrew $261 million, Rs 1,148.4 crore).

"Other emerging markets are more vulnerable to international uncertainties," says Nandan Chakraborty, Head, Research, Enam Securities, proffering one reason why FIIs buy into the India story. "Their economic growth is being questioned." The immediate trigger for the jump in the Sensex, however, has been the news of a settlement at the Reliance Group, India's largest private-sector enterprise.

Then, at 7,151.08 (which is what it was at when this magazine went to press), the Sensex isn't very far from 7,200. The question everyone is asking is, will it break gravity conclusively and move to a totally new plane before hovering around the 7,200-level, maybe dipping a couple of hundred points as it consolidates, or will it go back to bear phase once again? "The Sensex will not go back to the lower-end," says D.D. Sharma, Vice President (Research), Anand Rathi Securities. "We are not at the end of the bull run," stresses Motilal Oswal's Shah. That's right, we aren't. Here's why.

A fair valuation: While the Sensex may seem to be at stratospheric levels at its present levels, it is in fact fairly valued (in terms of price-earnings or p-e multiple). "The broad market is fairly valued (neither cheap, nor over-valued now)," says A.K. Sridhar, CIO, UTI Mutual Fund. To translate that opinion into numbers, at present levels, the Sensex's P-E multiple is around 15, almost the same it was in September 2001 when the index was at 3,000-levels. Given the recent performance of India Inc., this implies that a re-rating could just be around the corner. "The better visibility of the India story now means FIIs will be willing to pay a higher premium," says Tridib Pathak, CIO, Cholamandalam Mutual Fund. "The valuations can go up to 16-17 times (the average for the past 16-17 years)." That, however, may require a tipping point (aggressive economic reforms maybe, or China revaluing its currency).

The India story: The India growth story (rather, the India Inc. growth story) is still very much intact with corporate earnings growing at a decent pace. "The corporate earnings growth momentum will continue," says UTI Mutual Fund's Sridhar. "I do not expect any surprises on that front." Indeed, most analysts expect India Inc.'s profits to continue to grow at 15-20 per cent over the next few years. Conservatively, the Sensex should also grow at the same rate.

The colour of FII money: Forget quantity, the quality of FII money heading into India has improved. To most, India isn't the 'incremental-returns' element in their portfolio; it is the 'strategic-diversification' one. "(It is true that) short-term (oriented) FII money is riding the momentum, but it is the long-term India story that is driving money into India," says Shriram Iyer, Head, Research, Edelweiss Capital. "Most FIIs are long-term players and are making big purchases on corrections."

The economy: India, if surveys of business and consumer confidence are any indication, is clearly headed for better days. This magazine's BT-IRICS, India's first index of consumer sentiment, stands at an all-time high of 206 (base of 100 in August 2002; see On Top Of The World, Business Today, July 3, 2005). The job-market is booming and salaries (see Skyrocketing Salaries, Business Today, July 3, 2005) are rising rapidly across sectors. And thanks to a stable interest rate regime, the growth in retail lending is likely to stay strong for some time.

Now The Bad News

Actually, it isn't so bad. While the market will rise in the long-term, it could and will undergo a phase of correction in the short-, even medium-term. The first (a short-term correction), experts reckon, is imminent. "Money power is pushing the market up and once this phase is over, some correction and consolidation is expected," says Nilesh Shah, CIO, Prudential ICICI Mutual Fund. And in the medium-term, any major negative (higher oil prices, a bad monsoon, a strident Left seeking its pound of flesh from the ruling United Progressive Alliance at the expense of all else) could lead to a correction. At this point in time, it looks like oil could play spoil-sport; international oil prices have already crossed $60 (Rs 2,640) to the barrel and seem to be headed North. "If oil prices shoot up further, it will result in inflation, which in turn will result in high interest rates and tight liquidity," says Nilesh Shah, President, Kotak Mutual Fund. Given that the recent charge of the stock markets has been a function of liquidity, any change in that would affect fund flows to all emerging markets including India.

The interest of retail investors in the stock market, however, bodes well. The number of active DEMAT accounts with NSDL (a must for trading) has increased from 3.7 million in March 2002 to 6.5 million in June 2005 (it was 5.2 million in March 2004). And already, investments in equity funds have zoomed, from Rs 7,123 crore in all of 2004 to Rs 10,542 crore (till June). Then, there is the growing popularity of equity-linked insurance plans, and the government's decision to allow private pension funds to invest in equities.

Investors, however, will, as always, have to be careful. The era of the entire market being undervalued is over. Over the next year and more, sectors not directly affected by happenings in the international business scene, such as cement, consumer goods, banking and engineering stand to benefit. "The demand growth for cement is still continuing and, therefore, the pricing strength will remain with the cement companies", says Pathak of Cholamandalam. Consequently, the losers could be sectors prone to business cycles. "All possible negatives are not yet included in the prices of cyclicals like petrochem, chemicals, fertilisers and metals," says Prudential ICICI's Shah. Then, if there are winners, there will have to be losers.