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Indian equities have rallied smartly since the start of June with the Sensex up nearly 10 per cent in the last one and half months. Year to date, the index has gained 13.5 percent and outperformed many of the other emerging stock markets indices including BRICS. See table below:

Indian Stock Market performance amongst BRICS
Country	Name of the Stock Indices	Year To Date Gain (10th July 2012)
Brazil	Sao Paulo Bovespa	-5.4
Russia	RTS Index	-1.4
India	Sensex	14.0
China	Shanghai Composite	-1.6
South Africa	Johannesburg All Share	6.3

 

 

 

 

 

 

 

 

 

 

This is despite the fact that the rupee has been on a roller coaster ride with daily volatility of more than 50 basis points and all macro-economic indicators projecting a grim picture.

So what is driving the stock indices especially when not many are gung ho about the Indian economy in the current financial year? GDP for fiscal 2011-12 grew 6.5 per cent after an average growth of 8.4 per cent between years 2006-2011. On the other hand, Indian Inc.'s performance has not been one of the best in the recent past with growth hurting due to high interest rates and inflation. Most equity analysts are not expecting any meaningful improvement in earnings for the June quarter. No mega capex plan has been announced by any of the leading business houses recently. This indicates that many corporate are waiting for clear signals for the economy to revive before committing funds. Some of the biggest FDI projects announced in the country from Posco ($12 billion for 12 million steel plants in Orissa) and Mittal for setting up steel plants in Orissa and Jharkhand, are running behind schedule, and there is no certainty on when these would go on stream. Even if these projects eventually go on stream it would be of much lesser capacity than what was envisaged initially. On the other hand, some of the foreign players who have set up shops in India are scaling down their Indian operations as they feel that Indian government is not doing enough to push the economy back on the growth track. The latest one being Fraport closing down its business development office in India despite many of the country's regional airports demand huge revamp offering great business opportunities.

So then why Indian stock indices are doing well?  One of the key factors driving sentiment appears to be hopes that financial reforms would get the priority as Prime Minister Manmohan Singh is now heading the Finance Ministry. He has an impeccable record of taking economy out from the slump as he did smartly something similar in 1991. But the point is can he do it again? That time he had unstinted support from then Prime Minister Narsimha Rao and Congress party to push the reforms. But this time he is fighting a lone battle with no great support from his own alliance partners and its own party. It would be litmus test for Prime Minister to push three eagerly awaited reforms; FDI in retail, hike in the prices of diesel and last but not least FDI relaxation in Insurance sector. If Prime Minister can muster courage to push these three things it would send right signals to foreign as well as domestic investors.

I have feeling that market is discounting the positive news too soon. One must understand that this government does not have enough majority in the parliament to pass any meaningful reforms. With one of its key allies Trinamool Congress almost on the verge of breaking ties with the government it looks that this government has another task on its hands once Presidential election is over. We would continue to have policy paralysis and government fightiing hard to  survive at the centre. 

On the valuation front, Indian market does not look cheap. Trailing 12 months Sensex price earnings is in the region of 14.1 times which I believe is not very healthy especially when economy is unlikely to expand at significant pace. Normally stock market command PE 2 time country's GDP growth rate. By that logic market should command P/E not more than 12 times assuming that country may GDP grow at 6 per cent  in the current financial year.

As an investor, I would see this stock market rally as an opportunity to take some money off the table rather than putting more. I have feeling that this rally will soon fizzle out when market realizes that the new FM does not have enough leeway to push the reforms. Also, the government is all likely to face another headwind in the form of poor monsoon. Till date, progresss of Southwest monsoon has been quite unsatisfactory and there is a high probability that India may face El Nino situation in the month of August and September resulting below average rainfall this season. This would not only impact the food grain production but also purchasing power of rural India which of late has been the only engine that is firing. On the other hand, poor monsoon would impact industry as there would be power shortages and water scarcity.  In all likelihood, weak monsoon will knock off at least 50-75 basis points GDP growth rate making it more difficult for the government to meet its growth target.

So I feel any rally in the market should be use as an opportunity to book profits rather than allowing greed to dominate.

Sunil Damania is an investment expert and was formerly managing editor of Dalal Street Journal