It\’s a bull run, not a bubble

Projecting a profit and sales growth of 15% annually does not look wildly optimistic even after allowing for sundry stupidities, errors and accidents, says Swaminathan S Anklesaria Aiyar .

Now that the Sensex has risen at dizzying speed to cross 6,000, all and sundry are suddenly asking whether it is time to get into the market and buy shares.

The best time, of course, was when the market was at rock bottom, in the run-up to the Iraq war.

But ordinary folk tend to act like suckers, buying when the market is really high, and then selling when the market crashes.

That is what happened during the Harshad Mehta boom of 1992, the mid-1990s boom of 1995-96, and the technology boom of 2000. Will history repeat itself?

My own credentials as a stock market prophet are seriously suspect. I carry this burden lightly, however. The markets are inherently not predictable, and all supposed market experts took a beating in the last decade. The market humbles the most knowledgeable and arrogant of experts.

What experts can do is lay down scenarios, and leave you to judge how plausible they are.

So here is my own scenario, or guesstimate. I think that the current bull run is not a bubble but the start of a sustained global realisation that India has arrived as a preferred destination for global portfolio investment.

Now, perceptions of this sort can be highly volatile, and so I would expect Indian share prices to fall and rise in successive waves in coming years. Yet for those willing to ride the roller-coaster, I would say that the current Sensex level of around 6000 is a reasonable time to buy.

The Sensex has doubled in the last eight months, and nobody expects that to happen again.

Yet it is conceivable that Indian share prices could average a growth rate of 15% annually in the coming decade, reflecting profit growth of 15% annually for the better companies.

Inflation has come down from its historical trend of 8-9% per year, and may average 4-5% annually in coming years. So profit growth of 15% annually implies around 10% profit growth in real terms.

How realistic is that?

It is optimistic, but not wildly so. Assume that real GDP growth continues at around 6% annually.

That may seem to imply that demand will rise on average by only 6% in real terms, and maybe by only 5% if the savings rate goes up. Second, inflation may fall well below 5% annually, especially if the rupee begins to appreciate (as the BRIC report of Goldman Sachs predicts).

On the other hand an increasing proportion of the population will graduate from near-subsistence to the market economy. An even more impressive proportion is likely to graduate to the purchase of consumer durables.

And the consumer credit revolution will surely go on for a long time: it has barely scratched the surface so far. Consumer credit has greatly increased consumer access to durables and housing, and so sparked double-digit growth in real demand. Expect more of the same.

Projecting a profit and sales growth of 15% annually does not look wildly optimistic even after allowing for sundry stupidities, errors and accidents. We have such a long track record of glitches that it would be unwise to assume a smooth growth trajectory in coming years.

We could once again get into a near or actual war with Pakistan . Scams could cause gyrations in the markets. Global events could shake markets from time to time: we may see a nuclear attack by al Qaeda on US cities, or a new Asian financial crisis, or a political collapse in China .

Maybe India will suffer diseases even more virulent than SARS. Yet, even taking all that into account, an average growth of 15% seems within the realms of possibility.

Now, the consequences of a 15% compound growth rate are stupendous. If share prices keep pace with sales and profits, a 15% growth implies that share prices will double every five years.

That is, the Sensex could touch 12,000 by the end of 2008, and rise further to 15,000 by 2010. Even if profits and share prices average no more than 10% growth, the Sensex will touch 12,000 by 2010.

Those levels looks outrageously high today, and some readers might wonder if I have taken leave of my senses. Let me hasten to say that I am not predicting that the Sensex will in fact hit 12,000 in five years. I am merely saying this is the level implied by annual growth of 15% per year. We may or may not achieve that growth rate, but it does not sound ridiculous.

Next question: is our starting point of 6000 inflated? Those who have seen the Sensex double after April 2003 will say yes. In fact, price-earnings ratios (P/Es) in India are lower than abroad even after the bull run of the last eight months.

The P/E of the Sensex is 18.5 on the basis of earnings in 2002-03, but no more than 15 on the basis of estimated earnings in 2003-04. That is less than the historical 16 of US markets.

But, sceptics will say, India has been doing 5-6 GDP growth for two decades and the markets have not systematically enriched investors. Indeed, it has pauperised many.

Why should the future be any different?

Because India has now arrived on the global scene as never before. India is now seen by Businessweek, the Wall Street Journal and FIIs as globally competitive in not only software but back-office work, R&D and even manufacturing.

Every global multinational is formulating an India policy. US legislators are so fearful of India that they are legislating against outsourcing. If India is good enough to fear, it is good enough to invest in.

So expect FIIs to invest several billions of dollars annually in India in coming years.

That could prove enough to drive up share prices by 15% annually on average, with the path marked by wild gyrations rather than steady growth.

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