It’s well known that the Sensex hasn’t really done anything much since last October. But at a press conference held during the Morgan Stanley investment summit earlier this month, Ridham Desai, head of research and India strategist, said the Indian market had performed relatively well during the Greek crisis. That’s easily seen if we take a look at the MSCI indices. MSCI India (in dollar terms) is down 4.75% in the three months to 15 June and it’s down 0.2% year-to-date (YTD). In contrast, the MSCI Emerging Markets index is lower by 7.19% in the last two months and by 5.23% YTD. How have the developed markets performed? The MSCI World index is down 7.68% in the last three months and 5.15% YTD. But the US market has done even better than India—it’s down 4.67% in the three months to 15 June and flat YTD. Two factors would have contributed to the US outperformance—a heightened level of risk aversion, especially to Europe, and better-than-expected growth in the US. Moreover, if we compute the performance of the MSCI India index in rupee terms, the returns are much better—the index is down 1.23% in the last three months and 0.16% YTD. It’s the recent strength of the dollar that has skewed the performance.

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Both manufacturing and services growth has moved up across most countries in recent months. Why then are the markets still marking time? One reason is the looming fiscal crisis in Europe. Markets seem to have priced in worries about Greece—they scarcely batted an eyelid after Moody’s Investors Service downgraded Greek debt to junk. The concerns have now shifted to other countries in the European Union, with many predicting that Spain will be the next pothole for the market. The bigger picture is that the markets are worried that while growth is fine for the time being, the second half of the year will see a slowdown, as governments start tightening their belts. The Bank of America-Merrill Lynch survey of fund managers for June shows that global growth expectations have fallen sharply, giving rise to fears of a “double-dip". In the US, despite encouraging data on manufacturing growth and gross domestic product, the Economic Cycle Research Institute’s (ECRI) leading indicator index has turned negative. Asia can take a wobble in Europe in its stride, but if the US recovery too starts to falter, there is little doubt that all economies will be affected.

Why then is Nouriel Roubini, the New York University professor who predicted the crisis, warning that the Brazilian, Chinese and Indian economies may be overheating and developing asset bubbles? There are, of course, several reasons for the Indian market to continue to hold up well. Most importantly, as the recent industrial production data have underlined, growth is strong. Secondly, as has been repeated ad nauseam, the Indian economy is fuelled by domestic demand.

The problem is that all this is already priced into the markets. Valuations have come down—the Sensex’s price-to-book value multiple, for instance, is now around the same level it was back in May 2009. With risk aversion high, one cannot look forward to an expansion of the price-earnings multiple and a rise in markets is dependent on a positive surprise in earnings. Yet, as a Motilal Oswal Securities Ltd review of the fourth quarter results says, earnings revisions for the Sensex companies after the results have been minor. A Citigroup Inc. research note by Asia strategist Markus Rosgen hits the nail on the head. It points out, “Analysts have gone from strong upward revisions to an environment where they are revising earnings up less aggressively. This has raised uncertainty within markets. During the current phase of the market, earnings are paramount to the well-being of equities. Last year investors bought in anticipation of a recovery, now they want to see the recovery. The way this manifests itself is via earnings."

Citigroup analysts have been emphasizing that after the initial run-up in stocks as the recovery starts, year 2 of the recovery is typically a period when markets stop to catch their breath. In 2004, for instance, after the sharp rally in 2003, the Sensex was up a modest 12%. This cycle, of course, is fraught with much more uncertainty than what we faced in 2004.

But the narratives of a double-dip do not take into account the fact that governments are unlikely to sit and do nothing while growth slows. While Chinese policymakers have been trying to slow down their economy, it’s very unlikely that they will not act to prevent a meltdown. After all, China’s balance sheet is the envy of every country in the world. Similarly, if growth slows in the euro zone or in the US, that will mean monetary policy is likely to stay loose for longer. Dylan Grice, strategist at Societe Generale SA and bear market guru, had this to say: “The euro zone’s fiscal farce offers a revealing glimpse of the future: sovereign crisis begets banking crisis begets central bank nose-holding while the printing presses roll!! More immediately though, it’s making equities look interesting again." His point is that central banks will have no alternative but to print money and that will result in inflation, not so much in goods and services, but in asset markets. “One way to buy inflation—at least in its early stages," says Grice, “is to buy risk assets." In short, it’s a bubble all over again—but that is the bullish case for stocks in the current environment.

Manas Chakravarty looks at trends and issues in the financial markets. Comment at