Jhunjhunwala is right: Modi win hasn't overvalued markets; it's the start of a new bull run

Is the Sensex, driven by the euphoria over the election of Narendra Modi as Prime Minister and his party’s absolute majority in parliament, getting overvalued too soon?

I don’t think so. Even though punters are saying this bounce is driven more by optimism about the future than real corporate performance, the fact is even now the index is just about catching up on lost time.

Some people are worried about the pace of the Sensex’s rise. I am least worried by it. The fact is when the markets make up their minds on which direction to go, they don’t spend a lot of time discussing how to get there. They just do it.

Consider this reality: The Sensex peaked in January 2008 at over 21,000 - and even now it is barely up 15 percent from levels six years ago. Meanwhile, we have had six years of unremitting inflation - say, over 50 percent cumulatively. This means merely to catch up with its real value in 2008, the Sensex ought to be at 30,000 or more right now.

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Of course, there is nothing “ought to be” about any Sensex target, but I am merely pointing out that there is a lot of real value catching up to do for the index. What it needed was a trigger, and the NaMo bounce provided that.

This brings up the next question: can this sustain, and how high can the index go? If we assume that the economy will grow at six percent on an average over the next five years of NaMo rule - and this is a conservative estimate - and we also get 5-6 percent inflation, it means the economy will grow at 12 percent in nominal terms annually. The Sensex should grow at least a wee bit faster than that in nominal terms - say, 15 percent.

A 15 percent compounded growth rate over four years will give us a Sensex upwards of 42,000 by March 2018 - but in reality the index should be even higher if the new government goes in for big-bang reforms and all sectors of the economy start performing much better by the next fiscal year.

The most basic reason why the index in now on a virtuous cycle of growth is optimism itself - even if we don’t have too many policy changes by the NDA government. This is because a rising Sensex creates the conditions for easier raising of capital - exactly what you need for a revival in the investment cycle.

As the index rises and more companies come to the capital market, new money is pumped into productive investment, creating demand down the line.

If, simultaneously, the government itself kickstarts investment in infrastructure, the virtuous cycle will have two positive factors pedalling away furiously. As foreign direct investment starts kicking into many new areas, long-term capital will be available for growth.

Inflation will be tough to bring down quickly, so interest rates will take a while to tame. But once the capital scarcity starts abating with the buoyancy in the capital markets, banks themselves will find it easier to raise capital and resume lending.

While domestic rates are likely to remain sticky for a while, foreign loans will remain cheap - especially if India is re-rated positively after the next budget by the rating agencies. This means loans will be cheaper from abroad, and in a scenario where the rupee gets stronger, foreign loans will be doubly cheaper.

Market icon Rakesh Jhunjhunwala told The Economic Times in a recent interview that weare in a new bull market. He said: “Quality stocks are gaining, the number of new highs against the number of new lows is some 50 to one, good quality stocks are going into new highs. The markets are going up, but do not forget that bull markets will go up on a wall of worry. All I see is worry, people are not participating. But how long will they not participate? I have no doubts in my mind that we have started the biggest bull market that at least I will see in my lifetime.”

Since the Modi government has a majority of its own, one can reasonably expect it to last five years - till 2014. One can also reasonably expect the government to fix the economy - even if no radical overhaul is done. My conservative target for the Sensex in 2019 is 45,000, and optimistic target is 60,000.

I see no reason to disbelieve Jhunjhunwala’s claim that we are in the early stages of a new bull market.