There were two major outcomes on May 16. First, Narendra Modi-led BJP secured a clear majority in the general elections. Second, the Sensex touched 25,000.

Earning stability and traction is visible and the same has resulted in a slew of upgrades in Sensex EPS for FY15. On the changing macros front, inflation has eased from the high levels seen in 2013. Moreover, with modest MSP hikes for 2014-15 and announcement of cut in electricity rate across five-six States, the non-food and non-fuel inflation will be low in the next couple of years; with a major weight in the overall basket, food and fuel prices would drive down the overall inflation. El Nino factor notwithstanding, the favourable base for the year, would ensure that below normal monsoon would have only a transitory impact on inflation.

Of the twin-deficit hurting the economy, the Current Account Deficit (CAD) problem is remedied. With CAD as percentage of GDP below 2 per cent, financing the small deficit is relatively easier. Apart from CAD, the capital account balance has also turned into surplus, with portfolio inflows increasing in the past few months. FII inflows for January-March has been $5.2 billion. With sustained FII inflows, the external sector is unlikely to be a critical problem. Fiscal deficit, the other twin ailing the Indian economy, despite being high, is much better than the 2009 levels. Though there is chance of the fiscal deficit numbers climbing up in the next few months, good governance is likely to pave the way for better finances. The implement of GST would reduce the fiscal deficit by a substantial margin.

Capex recovery The capex cycle is also on the verge of a turnaround. The cost of borrowing (repo rate) does not have an impact per se on investment. It is the mix of policy paralysis, cyclical slowdown, accentuated by global overcapacity, which resulted in the investment quandary since 2008. We see capex recovery in FY15, led by proactive policies. The funding would be from the financial resources of households moving back from physical savings to financial savings.

The only factor missing now is the return of retail investors into the financial markets. Domestic MFs are still getting crowded out and are in the distinct danger of becoming increasingly irrelevant in the local equity markets.

Earnings Our contention is that the markets are ruling at levels which they should have been post second quarterly numbers of FY15. The earning upgrade cycle has started in earnest and would build up steam in the coming weeks. However, it is difficult to envisage an earning growth in excess of 18 per cent for the Sensex at present. Assuming that FY14 Sensex EPS is in the range of ₹1,310-1,325, at 25,000, the Sensex is ruling at a P/E of 16 for FY15. While it is not costly, it is not too cheap either. Perceived sustainability of earnings growth could ensure an upsurge in valuation metrics. Additionally, the natural fall out of ‘left out’ feeling by most investors and post facto buying by FIIs, could propel indices further on sheer capital flows. While optimists would say markets lead and rarely lag fundamentals changes, it would not be wrong to err on the side of caution. We foresee a smart upsurge in the short term, wherein the indices could spike up 5 per cent from these levels, but this could be frittered away and a sideways movement would ensure which would try the patience of even the most patient investor.

In such a situation, it becomes pertinent to be overweight on domestic plays, high growth stories and high EV but sharply deleveraging plays. Export oriented/Import parity plays could be volatile due to the impending gyration in currency, which could cast a long shadow on our markets.

The writer is Amit Rathi, Managing Director, Anand Rathi Financial Services

comment COMMENT NOW