Mumbai: There is little doubt that Indian shares are becoming relatively expensive after the widely tracked Sensex topped 30-month highs last week, and investors could be better off to take some profits off the table.

Some stocks have hit record peaks and the best performing major emerging market this year looks vulnerable to a correction.

The key factors behind the stocks rally have been a resurgent economy, rising incomes boosting consumer spending and swelling corporate earnings. Even though the central bank has raised interest rates four times since mid-March to cool inflationary pressures and factory output growth has slowed, the outlook for the $1.3 trillion (Dh4 trillion) economy remains upbeat with a forecast expansion of at least 8.5 per cent this year.

"Valuations currently reflect the known factors," said equity trader Kevin D'Souza. "The risks lay in the unknown ones and it's time to start discounting them." Buying by cash-flush foreign funds was the prime trend setter for the market with the inflows heading towards $12 billion since the beginning of January. But now there is increasing talk that they may switch to comparatively cheaper stocks elsewhere.

Credit Suisse analysts Sanjay Jain and Anand Swaminathan said Indian banks were expensive and recommended investors to trim holdings in State Bank of India and HDFC Bank. They favoured Chinese banks like Industrial & Commercial Bank of China and China Construction Bank as better bets among Asian financial stocks. The analysts also raised Australian financials to market weight, saying their valuations have become more supportive.

The 30-Sensex climbed 1.3 per cent last week to 18,401.82, extending a weekly run of gains to three. The index had touched 18,475.27 on Thursday, its highest since February 2008. It has gained 5.4 per cent this year, beating peers in other emerging markets and China.

Strong foundation

"The market looks ripe for a bout of profit-taking," said trader Ram Pradhan. "It's essential to build the foundation for the next rally. The fundamentals remain strong and the India growth story is well entrenched."

Pressure will also come from a shaky US economy, where jobless claims hit a nine-month high and a regional manufacturing index showed the first contraction in a year, sending world stocks to a one-month low on Friday.

The US economy grew at a 2.4 per cent annual rate in the second quarter, much slower than the 3.7 per cent pace in the first three months of the year, but recent data suggest the growth rate may be revised down.

While a troubled US economy could impact fund flows, and money managers could face redemption pressure from investors, market pundits are convinced that emerging markets will outperform. Market guru Mark Mobius believes that a global economic recovery may accelerate as growth in developing nations counters a slowing pickup in the US and Japan. "We're in emerging-market equities right now and we are very, very confident," Mobius, who oversees about $34 billion as Singapore-based chairman of Templeton's emerging markets group, said in an interview on Bloomberg Radio. "From an economic viewpoint the countries are doing very well and there's a lot of domestic buying going on in these markets."

Mobius said his biggest holdings are in Brazil, China, India, Thailand and Russia. He is not the only one to bet on the long-term outlook for India. Billionaire investor George Soros last week bought a four per cent holding in the Bombay Stock Exchange, Asia's oldest bourse that was founded in 1875, for about $35 million. Blackstone Group, the world's biggest buyout firm, said it was investing $300 million for a minority stake in unlisted Moser Baer Projects, which aims to commission 4,000 megawatts of thermal power by 2016 and 1,000 megawatts of solar and hydro power.

And in a report, "India and China: New Tigers of Asia", Morgan Stanley said that India's annual growth rate would reach 9 to 10 per cent by 2013-15, and would start outpacing China's expansion that would move to a sustainable 8 per cent.

"Over the next 20-25 years, we expect India to remain the highest growth economy among large countries," it said. "India could have the advantage of maintaining its high-growth phase for a longer period than east Asia did as UN data shows that India's age dependency will continue to decline until 2040."

- The writer is a journalist based in India