Sensex crosses 35,000 points. How many new highs will we see?

How do you define a bubble in an asset class - when the price appreciation in an asset class is ahead of all expectations and analysts' explanations. Something similar is happening in the Indian stock markets.

Everyday analysts and brokerage firms come up with new reasons to justify the new highs that BSE and Nifty Indices touch in every new trading session.

On 17th January, the BSE Sensex crossed 35,000, an all time high, on the news of (if we believe in what analysts say) government reducing its additional borrowing plans by Rs 30,000 crore to Rs 20,000 crore.

Remember, the government will still be breaching its fiscal deficit target of 3.2% set in February 2017 for the ongoing fiscal. Yet, the markets cheered the news of spending cut on additional borrowing plans by making 30 share Sensex 19 times its one year forward estimated earnings. The flight from 34,000 to 35,000 took only 16 trading session. The banking and the IT sector stocks have risen the most in this duration.

In calendar year 2017, the BSE Sensex gave returns of 28% while the NIFTY gave a notch higher at 29%. This happened in a year when government was not sure of its revenue generation post implementation of goods and services tax and the gross domestic product growth remained touched a low of 5.7%.

The demand graph in the Indian economy has been tepid and so have been the results by listed corporates. Commensurate with the low earnings and low demand in the economy, the Indian corporates have refused to make new investments to increase their capacities.

There has been a constant decline in private sector contribution to India's GDP growth. Gross Fixed Capital Formation (GFCF), a proxy for private investment in the country is set to be 29% of the GDP in 2017-18 as against 29.5% in 2016-17. In 2015-16, the GFCF was at 30.9%.

New investment proposals fell to a new low of Rs 79,000 crore in the quarter ended December 2017. The preceding quarter had witnessed a record low of Rs 1,15,300 billion.
While the government has been cutting its expenditure to control its fiscal deficit, which is already set to breach its earlier set target of 3.2%, in an economy like the one we have in Indian currently, this strategy can backfire as it will pull down growth.

India's economic growth is facing headwinds not from internal factors. Rising crude oil prices threaten to derail the math of government expenditure as well as India Inc's profitability. For government, expensive crude oil eats into the foreign exchange flow and dividend from oil marketing companies, as they are forced to withhold rise in petrol and diesel prices beyond a threshold.

Similarly, many sectors get hurt (especially aviation) in case of expensive crude oil, impacting companies' earnings.

But, all these concerns do not matter to a market that is flushed with liquidity. Thanks to lower interest rate regime in the country, people are forced to put their money in stock markets through mutual funds. More than 9 lakh systematic investment plans (SIP) accounts were added on average every month in 2017. 

So long as there is fresh liquidity in the market, company valuations do not matter to fund managers. They have to keep pumping in money in markets irrespective of the price of the stocks. Only when the liquidity dies, will the investors realise the value of the investments they are making today.