10 reasons for caution as Sensex breaches 20k

Now that we are so close to the stock market’s old highs, it is a time to be cautious, not plunge in with gay abandon.

The Sensex and Nifty just crossed 20,000 and 6,000 respectively, and from here it is just a hop, step and jump away to their all-time peaks. This writer believes these peaks were bound to be crossed before the budget, though making any such a prediction is always foolhardly. It is only the momentum that dictates these predictions, not anything fundamental. And the fundamentals have not changed at all.

[caption id=“attachment_575723” align=“alignleft” width=“380”]  The Sensex and Nifty are just a whisker away from 20,000 and 6,000 respectively. Reuters[/caption]

The watchword for ordinary investors from now on should be this: be there for the ride, but don’t let the punters ride on your wealth. Reason: this rally has only one leg, and it is not possible to get very far hopping around on one leg.

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Consider the following factors before investing.

First, the one leg on which this rally rides is foreign institutional investor (FII) inflows, who have poured $31 billion in rupee equivalents into stocks and debt -the bulk into stocks. Domestic investors have been selling during the recent rise. This means Indian retail investors and institutions are not positive on the markets.

Second, the prime reason for this inflow is the push effect-lack of investing opportunities in the west, and the relatively higher growth stories in the emerging markets. India is part of the latter story. The minute this liquidity surge ends or slows down, the market boom will be over.

Third, the best part of the boom may already be over. When the bulk of the foreign investment came in last year, it means the smart money is already into stocks. If the retail investor now wades in thinking stocks have nowhere to go but up, he could be in for a rude shock. The upside from here could be just 10 percent. When FIIs have already invested $25 billion in 2012, how is it reasonable to expect a further $25 billion in 2013 when India is not their only option?

Fourth, neither the world nor India is out of the woods yet. The US may have avoided the fiscal cliff, but avoiding it means higher taxes and spending cuts. This means the uncertainty over the cliff is over, but the reality of a growth slowdown is now predominant. The same is the case with Europe and India. P Chidambaram has his own fiscal cliffs to negotiate -the current account deficit and the fiscal deficit-and neither of them is anywhere near being handled well. Even if they are well handled, the short-term prognosis is slower growth. (Consider: if diesel prices are raised, will growth rise or fall?)

Fifth, a rising market will bring forth a rising supply of stocks. This can soak up the money now coming into stocks. The government is hoping to sell more public sector stocks, and even the LIC may thus be earmarking its money for bailouts here. Companies in deep debt-like Bharti-are entering the market, but the market has not been too excited by their offers. Consider Bharti Infratel. Excess supply of new stocks may put a ceiling on how high the markets can rise.

Sixth, the factors suggesting a rise in the market are the following-expectations about the budget, prospects of a fall in interest rates, and foreign inflows. This means there is a good reason to expect the markets to remain optimistic between now and 28 February. After that-or even a few weeks before that -all bets are off.

Seventh, after 28 February, the market will take its cues from what Chidambaram did and said. If he has actually bitten the bullet on reforms-including energy pricing, subsidies, etc-the market could rise even though the slowdown will continue. This is because the markets discount the future. A positive signal on serious reforms will be important in the budget.

Eighth, if the budget turns out to be a populist one with elections in mind, all bets are again off. The markets could go either way though the FIIs will not be amused. Higher government spending will boost the economy in the run-up to the elections, but the year after 2013-14 will see a serious economic crisis -which will not be good for the markets.

Ninth, the rupee will be a key signal to watch. Once again, its direction will depend on reforms, export performance (all downhill so far) and capital inflows. Any precipitous decline in the rupee to last year’s lows of Rs 57 to the dollar is bad news for everybody-the markets included.

Tenth, the key to a real market revival is the revival of domestic investment. Unless Indian companies are confident enough to invest in their projects, the short term upswing in the market will remain a mirage driven largely by foreign inflows. That’s the ultimate signal to watch.

The Indian markets will revive for real when Indians have regained their faith in the India story, not foreigners.