Sensex to scale new peak, but valuations may spoil the fun

FED FUND INJECTION FUELS CONCERNS

INDIA'S benchmark indices are poised to touch new highs this week which, while triggering ecstatic celebrations, has also provoked some concern.
    With the Sensex just a percentage point away from the all-time high of 21,206.77 it touched on January 8, 2008, and the Federal Reserve opening a $600-billion spigot, it is merely a matter of time before records are set. "We think the continued flows associated with continued injection of official liquidity into asset markets will put ongoing upward pressure on emerging asset markets in the months to come," said Michael Gavin and Alanna Gregory, analysts at Barclays Capital, in a client note.
    Indian equity markets are swollen with a rush of overseas funds that have already bought some 12 lakh crore worth of shares. Since corporate earnings and economic growth in emerging markets are superior to that of the US and the EU, banks that get cheap funds invest in the former, which give higher returns. So the US moves to flood the market with $600 billion of government bond purchases to revive its economy is not only defeating the purpose, but also harming developing nations by making their economies less competitive. The rupee has gained 5.2% to roughly 44.2 against the dollar this year, driven by dollar flows which lower export growth and boost imports, which will weaken the economy when the tide turns. Soaring asset prices a worry
THE Sensex is roughly 202 points, or 1%, away from its highest level.
    "Excess capital inflows will trigger sharp upward movement in asset prices in a short span, thereby increasing the risk of financial instability in the economy," said Edelweiss Securities in a report.
    This flow has boosted asset prices, making their owners feel rich, but putting most assets beyond the reach of the ordinary investor. Reserve Bank of India governor Duvvuri Subbarao expressed concern over the soaring asset prices during the review of the monetary policy on November 2.
    Surging stock indices have also made equities expensive, which may cause many investors to shun them. "There is a possibility of a correction in the short term if foreign fund inflows dry up suddenly for a few days, especially when domestic investors are selling," said Motilal Oswal, chairman and managing director, Motilal Oswal Financial Services.
    The Sensex is valued at about 20 times estimated earnings, China's Shanghai Composite at 17.5 times, Brazil's Bovespa is trading at 13.65 times and Russia is trading at 8 times.
    Some analysts, however, remain bullish about the long term since the demography and construction of infrastructure to keep pace with demand will keep the economy humming. The central bank has forecast 8.5% growth this fiscal.
    "In the short term, we might see ups and downs, but the long-term trajectory definitely indicates an upside. The Indian economy has a lot of leg left," said Sunil Singhania, head of equity investments at Reliance Mutual Fund.