India’s widely tracked diversified index, CNX Nifty surpassed the 10,000 mark last week. This psychological barrier concurred at a time when many experts and analysts were predicting the market would crumble under the pressure of high valuations.

The bulls took the bears for all they were worth, and the stock market indices caught many lackadaisical investors by surprise.

Clearly, these are increasingly difficult times for investors. When stocks were falling like a house of cards during the demonetisation phase, it was unforeseen that these would race to an all-time high. Some market experts still doubt the durability of the rally; as they have been questioning it for the past couple of years.

However, the markets have proven them wrong so far. You may have also come across experts and analysts who aren’t tired of discussing the brownie points of Indian markets, but they start sounding monotonous (hence less dependable) sooner rather than later.

So, now the question is, will the dream run in Indian equities end shortly?

First, let’s see what is driving the Indian markets up.

1. Rally in global equities
   
   The improving job markets, relatively stable inflation, and growing optimism about economic growth in developed markets, have sparked off a relief rally in global equities.
   
   Dow Jones Global Index, which captures the movement in global equities, has surged 13.1% on YTD (Year-To-Date) basis as on July 28, 2017. Over the same period, Dow Jones Global Index-Ex-U.S. jumped 16.3%. The Indian stock market indices have registered over 20% gains on YTD basis, while during the demonetisation phase the Indian markets underperformed as compared to most other prominent equity markets. However, as the economy recovered from the demonetisation shocks, investors flocked to Indian equities. In short, the current outperformance of Indian markets is primarily on account of the relative under-performance during that phase.
    
2. Sharp Rally in index-heavy stocks
   
   Aggressive buying by retail and institutional investors in index-heavy banking, telecom, auto, and mining stocks supported the upmove in Nifty. As the market valuations get increasingly expensive, investors are becoming more cautious about the quality of stocks; a good sign. Greater earnings visibility and relatively cheaper valuations sparked off a rally in Index-heavy stocks.
    
3. Domestic investors are becoming more aggressives
   
   Retail investors seem to have realised the importance of investing in equity markets through mutual fund SIPs (Systematic Investment Plans). Along with the sustained stock market rally, various investor awareness programmes have played a significant role in attracting retail investors to equity assets.
   
   As reported by the Economic Times dated April 20, 2017, the total worth of domestic holdings as on March 31, 2017, in BSE-200 companies was higher than those of the stake held by Foreign Institutional Investors (FIIs).
   
   The Assets Under Management (AUM) of domestic mutual funds grew at an annualised rate of 44% Between FY 2013-14 and FY 2016-17. This helped domestic markets absorb the selling shocks of FIIs.
   
   Moreover, Employees’ Provident Fund Organisation (EPFO) has decided to invest upto 15% of annual inflows into equities. In other words, EPFO might invest about Rs 22,500 crore in FY 2017-18.
    
4. Ban on naked shorts through P-Notes
   
   Exposure of overseas investors to Indian markets through P-notes is about 6.3%. To curb the speculative activities, the Securities and Exchange Board of India (SEBI) has banned overseas investors from taking a naked-short position in derivatives market.
   
   In simple words, foreign investors can go short on Indian markets only for the purpose of hedging (i.e. only when they have a corresponding long position). SEBI has set December 2020 as the deadline, before which P-note holders must unwind their naked-short positions. But for all practical purposes, it’s likely that most of the shorts will be covered near term contract-expiries. This reversal and anticipation of a bigger unwinding may also have pushed the indices higher.
    
5. Improving Fundamentals
   
   Factors such as higher budgetary allocations to infrastructure sectors, expectations of normal monsoon, greater political stability and an anticipated recovery in rural demand are making investors optimistic about the prospects of the Indian economy.
   
   International Monetary Fund (IMF) has forecasted Indian economy to grow by 7.2% in FY 2017-18. It expects GST to spur growth in India, but has also cautioned against the problem of bad loans. The RBI and Government have been trying to address this issue decisively now.
   
   Lower inflation and stable interest rates are other positives.
    

The road ahead…

Although Indian markets look overvalued, their comparison vis-à-vis historical numbers would be inappropriate. The structure of index keeps changing and sectoral allocation too. This is one of the most primary reasons why index valuations are not always comparable.

Secondly, we shouldn’t forget the relative strengths of the domestic economy. With a growth forecast of 7.2% for FY 2017-18, India is likely to become the world’s fastest growing economy once again. Stable capital flows and improving fundamentals may make valuations a secondary factor. Higher corporate earnings can potentially send equity indices even higher. If you hold back from investing in stock markets, anticipating their collapse due to higher valuations, you will probably miss out on good buying opportunities.

Nonetheless, you shouldn’t disregard the valuations.

What should smart investors do?

• Don’t invest blindly without paying heed to your financial goals.
• While investing in equity oriented mutual funds, don’t treat them as short-term avenues, instead invest for the long-term.
• Opt for Systematic Investment Plans (SIPs) offered by mutual funds. These let you benefit from the market volatility.
• Create a personalised asset allocation plan for yourself after considering your financial goals and risk appetite.
• Reach out to your Certified Financial Guardian for handholding in the path to wealth creation.
   

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