Sensex, Nifty50 at lifetime high: Why investors should exercise caution

Indian stock markets were exuberant on Monday morning, along with rest of Asia, as trading began after Joe Biden was called the next President of the United States. The Sensex went past its previous life-time high of 42,273.87 recorded on January 17, 2020, to hit 42,566.3 in the morning. Nifty50 too scaled the fresh peak of 12,451.8.

Other Asian indices such as the Nikkei and the Hang Seng were also up over 1.5 per as a Biden victory is seen as the beginning of a new phase of more harmonious trade relations between the US and other Asian nations. There are also hopes of another stimulus package from the US before the end of the year, that is pushing stocks higher.

While the initial spurt in stocks is not surprising, there are few reasons why investors need to temper their optimism from hereon.

Positives priced in

The US stock markets have been on a roll since April, brushing off the covid-blues. The S&P 500 index is up 8.6 per cent in 2020 while the tech-heavy Nasdaq 32.57 per cent.

The liquidity provided by the Fed, coupled with the recovery in unemployment, retail sales, and consumer confidence, has helped buoy sentiments. But businesses in the US are yet to go back to their pre-covid activity level. As a result, the blended earnings decline for the S&P 500 for Q3 2020, according to Factset.com, is -7.5% compared to the same quarter in 2019. The forward 12-month P/E ratio for the S&P 500 is 21.6, well above the 5-year average (17.3) and above the 10-year average (15.5).

Headroom for US stocks could therefore be limited from these levels. Further, Donald Trump had a large part to play in keeping US indices at record levels. With Trump on his way out, some profit-taking can set in.

Indian equities have also priced-in most of the positives visible at this juncture, and further rally is fraught with risk. The Nifty50’s trailing price earning at 33 shows very optimistic pricing. Any disappointment, slowdown in consumption after the festive season, can lead to a correction.

Biden’s policies, not pro-Wall Street

Biden has made it quite clear that he stands for the American middle-class and not Wall Street. He plans to reverse many of Trump’s tax cuts, once in power.

Biden’s tax proposals include raising the corporate tax rate to 28 per cent from the current 21 per cent, a minimum tax of 21 per cent on all foreign earnings and minimum tax of 15 per cent on book income. It is therefore evident that corporate profits are going to shrink if Biden pushes through his proposals. He also plans to increase the top individual income rate back to 39.6 per cent, from the current 37 per cent.

Trump, on the other hand. had promised to cut taxes further and boost take-home pay. He had also indicated that he would lower maximum capital gains tax to 15 per cent.

American companies have also gained by Trump’s trade wars and renegotiations of trade treaties that protected and helped grow their businesses.

While stocks are moving higher now, the rally may not last too long, if Biden makes good his campaign promises.

Uncertainty in the elections

Investors also need to remember that the last word is not yet said about the elections. Trump has challenged the results in US courts, and the outcome of those litigations is uncertain.

Also, the fact that Democrats may not have a clear majority in the Senate will make the passing of key bills difficult. This can lead to the status quo in many respects.

Investors in the US are counting on a logjam in the Senate to enable Trump tax cuts to stay. But volatility will return in both US and Indian stock markets soon.

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