Fireworks on D Street: Caution advised

It is festival time on Dalal Street: Sensex and Nifty are within striking distance of 'Lifetime peaks', hopefully the targets would be achieved in next few sessions. Where do the markets go from here? Retail investors are a bit confused about the future of the markets. The euphoria may last for a while on the back of excess liquidity available with FIIs. Majority of the analysts are now advising investors to enter the equity markets. But it is advisable to be cautious at these levels, as the risk reward ratio for investors has turned negative, at least for the short to medium term (i.e. next 3-6 months).

 

Investors are advised to closely watch the underlying indicators:

• Economic indicators: The IIP numbers and Inflation index will play a major part in deciding the future of markets. IIP numbers continue to stagnate, barring a few sectors like mining. The consumer confidence index is still lying low, as would be indicated by the slow pace of festival buying by consumers. However, rural demand is showing some signs of revival. But inflation continues to climb steadily on the back of higher food prices. The situation is unlikely to improve in the next few months, forcing RBI to pursue a hawkish interest rate regime. A sustained market recovery is not possible in such a scenario.
• QE tapering: The main reason for excessive liquidity finding its way into Indian equity markets is the decision by the Federal Reserve to postpone QE tapering. This has strengthened the Indian Rupee against the US dollar, lending stability to our Forex management. However, the threat to our currency is not completely over till such time there is a sustained revival in industrial activity to accelerate our export growth.
• Market volatility: Investors are advised to keep a watch on the Nifty Vix. After consistently hovering in the 20-30 range during the past month or so, Nifty Vix has closed at 18.39 today. The market is likely to turn volatile once again if the Vix moves above the 20 levels. The result season is still not over, and the coming month would witness Q2 numbers from weak corporates putting pressure on the Vix.

In such circumstances, investors are advised to exercise caution, and refrain from putting big money into the markets, as the threat of a reasonable correction are extremely high after the initial euphoria. Most large cap stocks are now in an overbought zone, investors may look for value in select mid-cap stocks after analysing their Q2 results. Otherwise, it's time to book profits and ensure yourself a decent Diwali bonus.