Chindia or China + India is the current rage as a consequence of the Chinese President's visit to this country. Chindia is usually referred to in connection with the growing clout that these two countries together contribute to global growth. Shouldn't the growth potential of these two countries be realised in their stock markets as well?

At first glance, that seems to be already happening. The MSCI indices for China and India, for example, are up 58 per cent and 44 per cent respectively this year, while the MSCI Emerging Markets has gone up only about 19 per cent. In short, both the Indian and Chinese markets have performed far better this year compared with the other stock markets.

Dig a little deeper, however, and it's easily seen that the state of the Chinese stock market has little to do with its phenomenal economic growth. In 2005, for example, the MSCI China index rose a comparatively tepid 15.6 per cent, well below the rise of 31.5 per cent in the emerging markets index and far below the 40 per cent leap for the India index.

Go back further, and the MSCI Chinese index fell 0.6 per cent in 2004, while the emerging markets index was up 13 per cent. India¡¯s was up 11 per cent that year.

The main reason for the lacklustre performance of the Chinese market is because the mainland's stock market has so far been little better than a casino. The state has used the market to raise money for unprofitable enterprises by listing them. Much new money is going to China, thanks to several good new listings and structural reform of the market. The upshot has been a 74 per cent gain in the Shanghai Composite index.

In contrast, the high valuations in the Indian market seem to have started taking their toll. The Indian MSCI index has been only slightly above the emerging markets index this month, while China has outperformed it by miles.

Another factor worth considering is that the rally in markets across the world has been driven by two main factors ¡ª one, lower oil prices and two, lower interest rates, as reflected in lower bond yields. But there's not much steam left in these factors any more and no new triggers are on the horizon. It's time, therefore, to put out the red flags for this rally.

The falling dollar

One reason for continuing capital inflows to India, despite the market quoting at a price-earnings ratio of 19 times 2008 earnings, is the weakness in the dollar.

The dollar recently fell to a five-and-a-half month low against the euro and a two-month low against the yen.

Data out of the US indicates that the housing sector has been hit very badly, with housing starts in October falling to their lowest rates in six years.

If the weakness continues, a rate cut would be a distinct possibility. That would lead to pressure on the dollar and to non-dollar assets becoming more attractive.

Many emerging market currencies have also rallied with the Singapore dollar at a nine-year high against the dollar and the Philippine peso at a four-and-a-half-year peak.

Back home, the suspicion is that the RBI is doing all that it can to rein in the rupee's appreciation. That's why the bond market is flush with liquidity and bond yields are falling. The depreciation of the dollar against the rupee has given foreign investors an extra 5 per cent gain since the lows reached in June. While the sensex is up 55 per cent from the depths it plumbed in June, the Dollex 30 is up 60 per cent.