It is still not time to take extra risks in the market

The sudden turnaround in Indian equity market sentiment has started tongues wagging about risk-on trades, high beta stocks and a shift out from defensives to risk stocks. The Sensex and Nifty have gained over 5.5 percent in the month to date while mid-cap indices have gained over 8 percent. The “New-Look” FM and PM have contributed to improved sentiments by pledging focus on reforms. Markets were also aided by the bond purchase announcements of the US Fed, the European Central Bank (ECB) and the Bank of Japan.

The improved market sentiment has led to speculation on a turnaround in sectors such as infrastructure, leading to the BSE infra index returning over 16 percent in the month to date while so-called defensive sectors such as FMCG have returned a negative 1 percent during the same period on the back of traders shorting high PE (price-equity ratio) FMCG stocks.

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The market may play favorites in such an environment where there are some signs of hope for the economy on the back of a government making the right noises. However it is going to take a while for things to change on the ground and while the market outlook may remain bullish, that bullishness will definitely not show on the financials of many beleaguered stocks in the short term.

[caption id=“attachment_466141” align=“alignleft” width=“380”]  Smart investors will leave those risk-on trades and other relative value trades to the speculator and focus on strong balance-sheet stocks that are reasonably valued.Reuters[/caption]

The government has just survived a key ally going out of the coalition and is now left to the mercies of “outside supporters” and these outside supporters have their own agendas. The government may find it difficult to push through more reforms in such a political environment. The government is also keen on placing a cap on borrowings and there will be spending cuts and focus on improving tax collections. A cut in government spending is not good news for infrastructure stocks as many projects are dependent on government support.

The improved market sentiment will not brush the ongoing investigations on “Coalgate” under the carpet. There will be more revelations on favoritism and kickbacks leading to a question-mark on many of the listed companies involved in the scam.

Public sector banks are not going to loosen their purse strings in a hurry. Banks are reeling under loans to state power distribution companies going bad, loans to real estate and infrastructure companies being restructured or going bad and loans to entities such as Air India being restructured under government compulsion. The fact that more restructured loans are expected to turn bad this fiscal due to a weakening economy will weigh on bank financials and no amount of improved sentiments is going to help bring about a turnaround in bad loans.

The sudden burst of reforms will not push up GDP growth, which is expected to fall to 5.5 percent levels for 2012-13 from revised forecast levels of 6.7 percent. The economy is still feeling the impact of high inflation, high interest rates, strained government finances and falling exports. Global economic growth will also not look up despite the liquidity infusion efforts of central banks. The RBI will lower rates but it will be done so in slow, small steps as inflation is still at 7.5 percent levels, which is much above RBI’s comfort zone of 5 percent and below.

Yes, the positive sentiments will take up markets as investors tend to be forward looking. However, given that there are still many risks out there, one should not increase portfolio risk by taking on highly leveraged stocks or highly speculative stocks. Smart investors will leave those risk-on trades and other relative value trades to the speculator and focus on strong balance-sheet stocks that are reasonably valued.

The markets are still tricky and one wrong move can cost one heavily.

Arjun Parthasarathy is the Editor of www.investorsareidiots.com, a web site for investors.