Come into my parlour.... The lure of the stock markets--

The markets have rallied sharply over the last couple of months. Since the elections were announced, there is hardly a poor day in the market. However, if we dissect the rally, it is a rally that is fed more by hope than by underlying fundamentals.

Whichever government comes in to power is going to walk on thin ice. Whatever be the good intentions in a manifesto, the treasury is insufficient to make intentions possible. Unless of course, there is so much global euphoria that foreigners flood us with money through the FDI/FII route. Given the fact that the markets are anticipating a Modi led NDA government to assume power after this election, the most likeable change preferred by the market, is already in the price.

Issues that the new government will have to address include continuing high fiscal deficit, high Current Account Deficit, Weak Industrial Output, Environmental activism leading to log jam in mining and if the rupee strengthens, the problem of weakening export earnings. In addition, global economic recovery and the “tapering” by the US Federal Reserve also have a big say on global trade and money flows.

So no miracles are in the pipeline. Most informed segments of the markets expect a 10 to 12 percent earnings growth in FY 2014-15 and a fiscal deficit in excess of 5%. There cannot be any dramatic improvement in FY 2015-16. Thus, in a way, the markets that are now trading at close to 18 times current year earnings are not very cheap either. There is optimism priced in to the stocks already.

Whichever government comes in, has its work cut out. There are programmes like the Cash Transfer of Subsidies, NREGA etc that are already committed. More freebies have been promised by all the parties. The biggest challenge is to revive infrastructure development. And a new government cannot change the fortunes of industries like mining which are stuck in legal quagmire.

At the best, what can be expected is a stable policy environment, provided the new government comes with a clear majority and does not have to depend on too many props to stay in power. We have seen what happens in a situation like that. Should there be a government with a ‘walking stick’ mandate, then there cannot be stability in policies. The last five years could have been better if there was continuity and stability in policies. So, if there is a repeat (even if it is with Modi at the helm), expect a déjà vu as survival of full term becomes the theme.

Global economy is at a cross roads. A lot of liquidity has been pumped in over the last few years, to keep economies going. As those taps dry up, the issue is whether growth can resume without the liquidity prop.

Corporate India is also not too healthy. Debt levels are high and banks are saddled with extremely high levels of non-performing loans. For investment climate to resume quickly, we need corporate India to be healthier. So, corporate recovery cannot be immediate but will take a couple of years to take root, provided there is a stable government with visible stable policies.

So, the markets are walking a tightrope. FII inflows in to India have been good on the assumption of a new government that would give stable policies. If something negative were to happen, that money flow can halt, if not turn negative. And we all know that our markets are primarily driven by the FII moneys.

There are a lot of good things that have to happen at the same time, in order for the stock markets to keep going higher. Most of the good news seems to have been factored in. The risk reward for the broad markets seems to be in favour of keeping away from the market for now.