The market?s sprint to 12000 has underlined all the old fears. Isn?t the sensex vastly overvalued? Hasn?t it run up too far too fast? Does it make sense to leap into one of the most expensive markets in the world? But jumping in is precisely what more and more domestic investors are doing. Having watched the binge that took the sensex from 4000 to 11000 from the sidelines, they?re eager to join the party.

Is that the right thing to do? Consider this: in 2005-06, the sensex rose 73 per cent while the earnings of the sensex companies are estimated to have risen by around 21 per cent. That means less than a third of the increase can be explained by earnings growth while the rest can be put down to a re-rating of the Indian market or liquidity ? call it what you will. Increasingly, it?s domestic rather than foreign liquidity that is driving the market and there?s still a lot of money waiting to be invested on the sidelines.

But forget about liquidity and concentrate on the fundamentals. Quarter after quarter, analysts have been saying that earnings growth is going to decelerate. Quarter after quarter, the strength of corporate India has surprised them and they?ve been forced to revise their earnings estimates upwards. This time too, the performance of most of the early fourth quarter results has been excellent.

According to data compiled by capitalmarket.com, sales of the first 214 companies to declare their results rose by 25.7 per cent in the fourth quarter compared with 25.1 per cent in the last full year. Net profits in the fourth quarter went up 29.2 per cent against 34.3 per cent for the full year. Operating profits rose 32.1 per cent compared with 30.1 per cent for the full year. Some deceleration!

In short, there are a lot of companies with profits continuing to grow at well above 30 per cent per year. No wonder investors are flocking to them.

Of course, this party hasn?t got so high on the ?fundamentals? alone ? much more potent stimulants have been at work. Brokering firm CLSA?s strategist Christopher Woods, in a recent report, says India is in the grip of asset price inflation, proof of which is also being seen in soaring real estate prices. Such booms, says Woods, always lead to a re-rating of stocks based on the value of the property owned by companies. That?s what happened in Hong Kong and Tokyo.

Consider what?s happened to the prices of some Indian property plays ? Unitech, Bombay Dyeing and Bata India have risen by 9199 per cent, 1206 per cent and 646 per cent respectively since the beginning of 2003. What?s more, Woods points out that many Indian companies are sitting on acres of prime land ? Infosys, ITC, the public sector companies who provide housing for their employees are leading examples. The point is that as the boom matures, these companies will no longer be valued for their earnings growth alone, but for the value of the assets they own. In short, high real estate prices lead to a wealth effect, which needs to be taken into account before making pronouncements on the overvaluation of Indian stocks.

Woods is right when he says we are a long way from bubble territory. Markets always overshoot and the sensex current PE of around 21.5 is still well below the peak of around 30 reached during 1999-2000 and the still higher levels reached in 1992 and 1994.