Prevailing economic conditions, both domestic and global, suggest the Indian stock market is poised to continue to rally in 2010, increasing the risk that a bubble is forming, according to analysts at research-led investment bank Noble Group.
The first factor supporting a stock market rally is strong GDP growth of around 8%. "In the last quarter, we saw that the GDP (growth) was 7.9%, so it's almost there," said Dipankar Mitra, Noble's lead India analyst for economic and country research. This is making global investors excited about India and confident that the structural growth of the economy remains quite strong.
The second factor is a pickup in the investment cycle. So far, the recovery in India has been driven by domestic consumption and government expenditure. However, corporate investment is expected to surge in 2010 due to the strong GDP growth which will increase capacity utilisation. "In the past, there has been a strong relationship between GDP growth and investments," said Mitra.
Mitra is not hopeful, however, that net exports will support India's GDP growth in the coming year. "Though we have started to see positive export growth since last month [November] and (total exports) might end the financial year close to $160 billion to $165 billion, it will still fall short of the $185 billion achieved in [the financial year which ended March 31, 2008]," explained Mitra.
The third factor Mitra cites is a comparison of macroeconomic data over the past decade saying 2010 looks like it is going to be a year like 1999 (the Bombay Stock Exchange index, the Sensex, was up 64% that year) and 2007 (Sensex up 47%) due to strong GDP growth, inflation on the higher side and supportive policy signals. Currently, financial markets are in good shape and inflows from foreign institutional investors (FIIs) are likely to continue. The combination of these factors suggests that the Indian stock market is on a bull market course akin to 1999 and 2007 rather than a bear market course like the one in 2002 or 2008.
The final major factor is US fiscal and monetary policy which is likely to remain loose for the better part of 2010, indicating a continuous flow of liquidity into emerging markets.
Any reversal of monetary policy by the US will affect market sentiment worldwide, and any meaningful increases in interest rates by the Fed will certainly affect banking stocks and the asset bubble globally.
"But up till now, there's no major threat of the fiscal policy withdrawal as it was announced last [month] that Tarp [the troubled asset relief program] will be extended till October 2010. All of this is supportive to the rally [of the Sensex]," he continued.
Other factors boosting the Indian stock market include the recovery of domestic consumption from the drought of 2009 and a peaceful external situation. In addition, Mitra pointed out that stocks in the infrastructure and power sectors will rally this year as they receive strong policy support from the Indian government.
Mitra is cautious on predicting how long the bubble may last: "The interest rate cycle might start moving up with the strong GDP performance and relatively high inflation. If it does, banking stocks will be affected severely as we've seen in the past. And if there's a substantial increase in interest rates, it might induce an exigency to exit from the easy monetary stance, then we will really see the bubble bursting."