Market rally: It's not a bubble, but be cautious

In the beginning of February 2014, the BSE Sensex was hovering around 20,000 and no one predicted it to touch 25,000 by the end of the year. Deutsche Bank came closest when it predicted in January a Sensex target of 24,000 by the end of 2014. On Wednesday, the Sensex crossed 27,200 to touch a new high, rising more than 35 per cent in the past six months. So, what has changed in the past few months?

The biggest factor driving the stock market is the new government led by Narendra Modi . After the new government took office in May, brokerages have raised their Sensex targets. In May, Deutsche Bank revised its target for the end of end of 2014 to 28,000 while Japanese brokerage house Nomura in August raised the Sensex target to 30,310 by the end of August 2015.

Does the market still has room to rise further or is this a bubble? Sustained flow of money is one of two reasons for the market's rapid rise. Liquidity continues to flow into the Indian market. Both foreign institutional investors and mutual funds are buying Indian equities. Till the liquidity tap continues to flow, Indian equity markets won't face any problems and will remain buoyant.

Modi's visit to Tokyo, where Japan committed to invest $33.5 billion in India is being seen as a positive development for the market. And market observers feel that Modi's visit to the West will bring in more flows into the country, which would augur well for the economy as well as for the market. One can always argue on the basis of valuation that the market isn't cheap. Yes, it isn't cheap but it is also not euphoric.

Early last month, bears were caught on the wrong foot and had to recover their short positions that pushed the market higher. The market is going up also because players that are holding onto shares aren't selling, while others who have money are accumulating stocks at these levels on expectation that India will deliver in the long term. So in one sense there is some sort of re-rating happening with players globally becoming risk takers.

But India should not be looked in isolation as others emerging-market economies have also seen similar interest among investors. Coming back to India, the sentiment is positive and, like always, the market has run ahead of fundamentals. The market has discounted that the economy will not show any huge improvement in next 15 to 18 months. Though initial Q1 economic indicators have been good, the market trend will depend on corporate performance.

Till India Inc continues to deliver impressive performance quarter after quarter, the market will remain firm. The market will react positively on any reform measure taken by the government. In the near term, the government's disinvestment programme will start in next two-three months.

All eyes will also be set on the European Central Bank (ECB). There are expectations that the weak health of euro-zone countries will prompt the ECB to pump more money into the zone. This will, in turn, lead to more liquidity flow into emerging markets like India. The reason why the market doesn't seem to fall from here on and will remain firm is positive macro and micro developments like a fall in oil prices, a stronger rupee and impressive micro numbers.

Easing tension in West Asia and news of a ceasefire between Russia and Ukraine have added to the positives. While the momentum is pushing the market to new highs, investors should be careful and stick to companies that have a strong balance sheet. Quality is key at current levels, because even if the market corrects sharply - which isn't expected at this juncture - any correction would not erode much of investor monies and they would be the first to recover after a correction. Most importantly, investors should also check at what levels they are getting into the stock as timing is key for gaining from any stock.