Markets unlikely to get back to lifetime high soon

Currency, Fed Reserve commentary on rates and stretched market cap to GDP ratio likely to cap further rise

Hope is a potent ingredient in market rallies. However, such rallies tend to have short legs. Indian equities have been riding a hope wave for 12 months and improved macro economic fundamentals. But little of this has translated into higher earnings; the currency's strength is eroding export income. After a 30 per cent increase in the markets, experts are turning cautious as valuations look stretched and global risks take centre-stage again. The signs have become visible in the futures market, too.

The fist meeting of the US Federal Open Market Committee on March 17-18 is expected to open doors to rate tightening later this year by dropping 'patient' from its stance. Morgan Stanley's US Economics Research team says: "We do not think financial conditions will tighten materially further in response to this meeting, as (Janet) Yellen artfully guides financial markets toward an understanding that removing 'patient' does not signal an imminent rate hike but opens the door to a rate hike at any given meeting going forward."

The other big risk is the rupee's resilience against the dollar and other currencies such as the euro. The rupee has remained stable against the dollar, unlike many other emerging market currencies. While this might signify India's improving macro economic fundamentals, the same would impair corporate earnings.

Software services exporters are already seeing their revenues and profits come under pressure, due to cross-currency volatility and resilience of the rupee. Morgan Stanley's Ridham Desai says the real and nominal appreciation of the rupee threatens to derail India's nascent growth story, as well as stock returns.

If the currency continues to appreciate on strong capital flows, double-digit earnings growth estimates for FY16 could be at risk. Given the weak earnings show in the third quarter, a similar story is expected in the fourth quarter and the first two quarters of FY16 as well. IIFL believes the Nifty's 9,100-plus peak seen last week might take a while to re-conquer and investors would do well to scout for individual stocks rather than take position in Nifty or Bank Nifty.

There is another data point to consider. India's market capitalisation to GDP ratio stands at 0.88 (growth estimates under the revised GDP series and present market capitalisation), while the 10-year average is 0.78. Experts say if one factors in the older series, this ratio would be above one. It means the markets are in bubble territory.