While the stock markets are buzzing with activity on the back of strong support from foreign money flows into the country, whether the fundamentals -- i.e. earnings growth prospects of corporates -- actually support the current high valuation levels is debatable.
Here are the three key factors to reckon with.
1. Among various factors that were having a bearing on the stock market sentiment, the sharp spurt in crude prices over the last one-year was a cause of concern. Now that crude has fallen from the highs of $55 per barrel and with futures showing some kind of softening trend, markets seem to be enthused.
While we believe this is a positive, on a year-on-year basis, prices are still on the higher side and to that extent, the impact on margins of corporates is unlikely to reduce. Already, auto and paint companies are contemplating a price increase in December 2004 onwards.
2. Rupee appreciation is another factor that the investors have to keep in mind before taking investment decision.
We did a comprehensive study of the top exporters and importers in the country and how the appreciation could impact earnings growth in the short-term.
While software companies seem to have hedged their dollar exposure for the next twelve months, we believe that pharma and trading companies could feel the pinch.
3. Most important of all, the flow of money into the securities market has been very strong in recent months. While the inflow was slower in the first half of the calendar year, there has been a marked increase in the second half.
While the India story is still alive from a long-term perspective, we believe that any sharp rise in interest rates in the key developed markets like the United States could impact money flows into the country in the future.
In this context, banking on strong foreign institutional investor (FII) support may be a risky strategy for investors.
To conclude, given the rally in the last six months, investors would be well off to utilise this as an opportunity to book profits, if the target price is achieved.
Tread with caution at current levels and it is pertinent to look at the downside before the upside.
Equitymaster.com is one of India's premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.
More from rediff