Sensex pierces 28,000 mark for the first time but investors should be cautious

Bulls have taken the pole position in the Indian equities, pushing up the Sensex beyond the 28,000 mark today. The markets have been on the rise and hitting record highs ever since the Bank of Japan announced an expansion of its stimulus for the economy. Now there are expectations that the European Central Bank too will do something similar to boost the sagging economy there.

Adding to the bullishness is the fall in crude oil prices. A decline in international oil prices is always good for India as it will pull down the inflation here and prompt a rate cut from the RBI. There were also rumours that a rating upgrade for India is also on the cards. Rating agencies such as Moody’s and S&P have been upbeat about India after a stable government under Narendra Modi assumed office in May.

The government has taken a few reform measures already, which has given rise to hopes more such steps are in the works.

However, what has driven the markets to the new highs is clearly the global liquidity. FIIs, flush with cash, have been pumping dollars into Indian equities. In the last 2 days, after the BoJ announcement, they have pumped in Rs 3,320 crore into Indian equities. On a net basis, foreign investors have pumped in a whopping Rs 85,312 crore in 2014 thus far, while the corresponding inflow from MFs stood at just Rs 14,059 crore.

Here are four reasons why it is advisable for the charging bulls to hold their breath and watch out.

1) Earnings yet to see meaningful recovery: After the new government assumed power, nothing much has changed on the ground. Take corporate earnings for instance. A Firstbiz analysis of 159 companies, excluding banks and NBFCs, has shown that there has indeed been a surge in profit. But there has not been a corresponding boost in revenue. The profit growth is mostly because of the low base and fall in input costs. Had there been a meaningful economic recovery, it would have pushed up demand. This, in turn, would have reflected in the revenues. A case in point is the recent vehicle sales data. According to the data provided by various companies, sales have been tepid during the festival month of October, when usually the sales witness a spike. Maruti, the country’s largest automaker, saw its sales decline 1.1 percent during the month.As many experts have already warned, an economic recovery is far away.

2) Banking sector worries: There has not been a let up for the banking sector yet. As of June, the sector has an aggregate stressed assets of Rs 8.5 lakh crore, which is about 14 percent of the total loan given by Indian banks. Since then, the NPA situation has only worsened. At least that is what the earnings of banks are indicating. According to a research note by India Ratings, the restructured assets of banks are likely to surge by Rs 1 lakh crore by the end of this financial year. This could significantly add up to the capital burden of banks since current norms require banks to set aside substantial amount of money to cover stressed assets. S&P’s recent downgrade of IOB is a writing on the wall.

3) Rate cut is unlikely: The government and the industry lobby may want a rate cut desperately. They have been routing for one as inflation has fallen due the fall in crude oil prices. But RBI Governor Raghuram Rajan is unlikely to relent. This is because he has already factored in a fall in inflation. The RBI in its September 30 policy review had said that the fall in inflation is largely because of the large base effect. 

“The full impact of the skewed rainfall distribution carries risks to the future path of food inflation. Base effects will also temper inflation in the next few months only to reverse towards the end of the year. The Reserve Bank will look through base effects,” Rajan had said. What this means is that the central bank is unlikely to cut interest rates any time soon.