The Sensex is back to 21,000, the level it reached in intra-day trading in January 2008. The market rolled over shortly after reaching that level last time, and it’s entirely understandable that investors don’t want a repeat performance. After all, the current rally too has been based on foreign institutional investor (FII) inflows, and many uncertainties persist in the global economy. But, apart from the similarities, there are also quite a few differences between now and 2007-08.

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Perhaps the first thing to keep in mind is the growth in the Indian economy since then. Gross domestic product (GDP) for 2007-08 at current market prices was 49.5 trillion. For 2010-11, the Prime Minister’s advisory council’s estimates put it at 70.3 trillion. That’s a growth of 42%. So while GDP at current market prices has increased by 42%, the Sensex has gone nowhere. That difference should indicate the market is on a firmer footing now than in early 2008. In contrast to the 42% rise in nominal GDP, the rise in total market capitalization, which also takes into account the newly listed companies, is around 8%, so on that metric too there is room for comfort.

Also, in January 2008 the repo rate was at 7.75%, well above the current rate of 6.25%. That seems to underline we’re still in the early stages of the cycle.

How expensive is the market? The trailing price-earnings (P-E) multiple for the Sensex is around 24, while the price-to-book multiple is 3.9. At the January 2008 peak, the trailing P-E was at 28.5 while the price-to-book multiple was much higher, at 6.9. But since the market is forward looking, trailing P-Es may not tell you much. What about prospective P-Es?

The Sensex at 21,000 was at 25.2 times 2007-08 earnings. This time, at the same level, it is around 19.6 times fiscal 2011 Sensex earnings. If January 2008 marks a peak of liquidity-induced frenzy, then valuations are still some way off from it.

There are other differences. Retail participation, for instance, has been almost totally absent. There is no talk by research analysts as yet about “embedded valuations". On the contrary, people are advising caution at every stage.

In January 2008, the yield on the 10-year treasury note in the US was 3.8%, much higher than today’s 2.5%. This time, the incentives to pour money into emerging economies such as India are, therefore, stronger. And with the US Federal Reserve prepared to continue to loosen the monetary purse strings till the economy gets better, which it’s unlikely to do in a hurry, the rush of money into non-dollar assets should continue.

Surfing this tsunami of liquidity is fraught with danger—high oil prices and an expanding current account deficit are some of the dangers. Last week, gold climbed to a record high, crude oil to a two-year high, and copper to a 28-month high. Investors will need to keep a wary eye on FII flows to check whether the tide is starting to run out.

In 2007, for instance, FII flows started to reduce well before the final blowout in January 2008. This time, though, it’s just a fledgling bubble yet. And it might get much bigger than the previous one before it leads to an even more spectacular bust.

Graphic by Paras Jain/Mint

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