Be Wary of the Sensex

India is just one destination, among many, for foreign institutional money. This fact becomes clearer every time the Indian market responds to global cues— be it the subprime scare in August or the 50 basis points cut in the Fed rate by the US Federal Reserve the next month. Global money flies out quite quickly in nervous times and then comes sloshing back in more propitious ones.

Over the last few weeks, since the Fed cut rates and unleashed easy money into the global economy, the Indian markets have seen an inflow of over Rs 11,000 crore; this has taken the stock market indices to new heights. Do the fundamentals of the Indian economy warrant this exuberance? Most people believe that it does not.

As we get into the corporate earnings season, the rationale behind the rise of the BSE Sensex will be tested. Quite a few market watchers believe that it will be virtually impossible for large cap companies to beat the blues this time. And small- and mid-cap companies, in any case, do not seem to have benefitted equally from the incoming flows.

There are many reasons for the blues. Apart from the stronger rupee, the higher interest rates will affect the July-September results. The first quarter results of many companies got a leg-up from generous other income components as a result of treasury operations. That is not as likely this time around. Moreover, the impact of any moderation, if at all, in interest rates (RBI’s credit policy is due later this month) will only be visible in the next quarter.

So, the market seems to have run ahead of itself. Added to the risk of lower corporate earnings is the possibility of political turmoil at the Centre over the still unfolding UPA-Left standoff over the Indo-US nuclear deal.

Also the prime generator of this market exuberance—the US economy—may show far deeper signs of distress arising out of the subprime malaise than has been evident till now. Quite a few experts believe that the real depth of the subprime problem is not yet known. And in these times of fast global financial flows, any sharp downturn in the global risk appetite will affect India negatively. That is the flip side: it has, thus far, benefitted from the higher risk appetite of global investors. Over the next few months, much will depend on how well the Indian economy grows and how it responds to the investment impetus. Much will also depend on Corporate India’s ability to squeeze out earnings in somewhat adverse and uncertain times. So, watch out for the earnings season with a hawk’s eye.