On Tuesday, India's benchmark stock indices, the Sensex and the Nifty, surged past the important psychological milestones of 20,000 and 6,000 respectively. Given the current momentum — the markets have gone up by 10 per cent in a short two-week period — it is very likely that the indices will surpass their all time-highs recorded in early 2008. Government spokespersons have reacted with moderation: there have been no exaggerated claims about the heady rise. Nor have there been hasty inferences. The continuing positive macroeconomic news from the domestic front is boosting the investor sentiment. The economy seems capable of registering a nine per cent annual growth rate and possibly moving on to an even higher trajectory. Manufacturing especially, and also services, have shown robust performance, and agriculture seems poised to recover on the back of good monsoons. However, it would be wrong to attribute the stock market behaviour to just one or two factors. While strong corporate earnings and a sound capital market edifice have been two other positive factors, India's strength has to be seen also in relative terms. With cross-border capital flows into stocks becoming a major factor in a globalised economy, Indian markets are perceived as a haven by those who fear a double-dip recession in the United States and are concerned about the debt crisis in Europe. Foreign institutional investors have pumped in more than Rs.3,300 crore in just two trading sessions recently.

Indian stock markets have consistently been outperforming their peers. The crucial question is whether Indian stocks are overpriced. Stock indices are currently quoting at more than 21 times earning for the trailing 12-month period. Brazil, Russia, and even China have lower price-earning (P.E.) multiples. Unlike in the stupendous rally of early 2008, domestic investors, especially the retail investors, have been circumspect. Even the domestic institutions and mutual funds have been sellers, preferring to book their profits. The over-dependence on overseas investors is surely a handicap. The rally can reverse itself without any warning. The foreign flows are guided, to a large extent, by the economic circumstances in the developed countries. This was amply proved by the abrupt reversal during the second half of 2008 when the financial crisis acquired menacing proportions. High stock prices, insofar as they are prone to sharp corrections, pose a variety of threats to the individual investor and the economy. Small investors might be tempted to enter the markets at these high levels. For the macroeconomy, the foreign inflows have not been an unmixed blessing. Apart from fuelling asset price inflation, they have brought about a sharp appreciation of the rupee.

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