The Sensex recorded a new life-time high 39,115 and the Nifty moved close to its previous peak on Monday, but the volatility that followed in the last hour shows that market participants are far from complacent. While both the market benchmarks ended financial year 2018-19 on an upbeat note, with around 16 and 14 per cent return respectively, the year was marked by unprecedented volatility. Large-cap stocks that form the Sensex and the Nifty managed a better performance, thanks to the support of large institutional investors such as mutual funds and insurance companies, but the small- and mid-cap indices ended the year with losses.

There were multiple factors that made Indian equity market see-saw over the past fiscal year. The trade war unleashed by the US on all its trade partners including China raised concerns of a global slow-down and kept equity investors nervous through 2018. Tightening liquidity conditions in global markets with aggressive rate hikes by the Federal Reserve and monetary tightening by other central banks reduced flows into emerging markets including India. Foreign portfolio investors turned net sellers in Indian equity and debt in 2018, thus applying pressure on the Indian rupee that was already reeling due to the spike in crude prices. Besides global factors, there were a host of domestic factors that made Indian stocks decline. One, introduction of taxes on long-term capital gains led to some profit booking, governance issues began haunting smaller stocks, new norms enforced by the market regulator on re-categorisation of mutual fund holdings too caused a sell-off. To add to this, the IL&FS crisis tightened liquidity for onward lending among non-banking finance companies, threatening to destabilise the entire economy. Indian stocks have however managed to shrug off these worries over the past few weeks. The current rally was primarily driven by hopes of the current NDA government returning to power. With foreign investors ploughing in close to $6.7 billion so far this calendar year, sentiment has revived. Expectations of a rate cut by the Reserve Bank of India in its forthcoming monetary policy meeting is further driving this.

There are however many reasons why investors need to stay watchful. One, valuations have become extremely pricey since the rally is not backed by earnings growth. The Sensex is currently sporting a price earning multiple of 29 times based on trailing twelve month earnings, according to Bloomberg; much higher than the 22 times PE multiple towards the beginning of April 2018. While revenue growth was healthy, India Inc’s profitability was hit in FY19 due to increasing commodity prices, a weak rupee and increasing borrowing costs. With private capex cycle yet to resume, private consumption getting impacted due to rural distress and NBFC crisis, banks yet to be free of their NPA burden and regulatory issues continuing to dampen real estate and power sectors, a sharp revival in earnings is unlikely in FY20. Besides these, election-related uncertainty too is a risk.