Indians see 'bull,' not bubble, for stock market

The story from India's answer to Wall Street has not changed for months now. Every day, it seems, brings a new record high for India's stock exchange.

Three years ago, the Bombay Stock Exchange's Sensitive Index, or Sensex, topped the 6,000 mark for the first time since its founding in 1979. Tuesday, it stood at 14,211, 96 points off its record high. It has added more than 4,000 points in the past year alone.

Long passed over as being too volatile, Sensex is now among the most sought-after emerging market indices, as investors abroad pour money into companies whose profits are increasing by one-third every year. In the past five years alone, foreign ownership of the market has more than tripled to 20 percent.

Yet, like America in the 1990s, when the Internet seemed to have created a "new economy" freed from the gravity of boom-and-bust cycles, there is a question of how long this can continue – and whether the frenzy is creating a bubble.

Given the Indian market's feast-or-famine history, it is an important question for investors from Mumbai (Bombay) to Memphis.

"There is an amount of exuberance in the system," says Jay Sinha of Ambit Capital in Mumbai. But perhaps not the "irrational exuberance" that Alan Greenspan famously observed in the 1990s boom, Mr. Sinha says. Though many experts agree that Indian companies are somewhat overvalued, the core of the market's growth is founded on solid economic footing, they add.

After all, Sensex investors are dipping into concrete manufacturers and construction companies – not Internet startups with beanbag chairs and catchy names. Challenges of politics and infrastructure remain, which could still slow the market's upward march. But the Indian economy has clearly changed gears, analysts say, giving investors reason for their continued optimism.

"In the overall economic environment, it seems that not only is growth high, but it is sustainable," Sinha says.

The tremendous growth can also be seen in enormous corporate profits, which are increasing by 35 percent a year in many cases. With markets in Western nations largely stagnant, foreign investors have been increasingly willing to look abroad to beat their projections, and India's profit rates have proved too tempting to ignore.

"Within the emerging markets, India is one of the highest growth markets," says Anup Maheshwari of DSP Merrill Lynch Fund Managers in Mumbai.

By Sinha's statistics, it has provided a 22 percent return on investment, the highest of any emerging market. This has fed on itself, with investors driving stock prices up in hopes of gorging on Indian companies' substantial profits. The result, say experts, is that many Indian companies are probably overvalued.

The disagreement is about how much. Some argue that it is only slight – 10 percent at the most. Others suggest that a 15 percent growth rate for company profits is more sustainable. "It will not fall right away to 15 percent, but that's where the market will revert to during the next four years," says Mr. Maheshwari.

But he notes that 15 percent growth for a business is hardly a recession – or even a so-called "soft landing": "Fifteen percent is not a bad rate of growth."

Indeed, the economic news out of India tends to be almost universally good these days. So good, in fact, that India's central bank is expected to raise interest rates Wednesday in an effort to keep inflation down and the economy from overheating.

Over the past five years, the economy has grown at an average rate of 8 percent a year, and that is increasing. The nation's famed information-technology sector now has annual exports of $30 billion – up from $5 billion three years ago. The long-moribund manufacturing sector is growing at an 11 percent clip. [ Editor's note: The original version incorrectly stated the amount of India's information-technology annual exports.]

It is a picture of a country in the throes of substantial and widespread growth, and so long as it continues, experts say, the market will follow.

"Everything hinges on whether we expect our growth to continue," says Surjit Bhalla of Oxus Research in New Delhi.

He sees no reason for it to stop, short of some global disruption that would affect all markets. After all, the primary driver of India's growth is domestic consumption.

On one hand, concrete and steel are needed for India's mad dash to build power plants and improve rutted roads. But perhaps more significant, India is making more and spending more. Today, 1.9 million Indians say that they make $1 million, according to Sinha.

The effect is seen in busier mills and manufacturing plants, which are at 80 percent of capacity, he says: "It says you need to add more capacity to meet demand."

There are constraints on this growth, however. The current boom is largely the product of reforms and improvements to industry made in the 1990s. Some worry that the current success has created contentment and the pace of reform has slowed. For example, the banking and insurance sectors still have strict rules regarding foreign investment.

"We need to take that next step forward," says Maheshwari. Still, optimistic observers argue that India is going though the same sort of transformation that the United States went through in the 1980s, when the Dow Jones Industrial average sat at 800. Now it is above 12,000.

"The structural break in the US had to do with inflation breaking," says Mr. Bhalla. "In India, it is much more a story of the middle class."