Stock markets are a tough place to stake your reputation on, even as it turns out, for Warren Buffett!  They say, when Time (Magazine) carries a story on the death of equities, the market finally bottoms – this time, it has taken the crucifixion of Warren himself to bring the market to a bottom!  We continue to have faith in the man and the master because stock markets don’t pander to the cult of personality and we all make mistaken assumptions in our models.  This is precisely the reason analysts love to stick in a bunch, so that they cannot be singled out – so much for conviction!!

 So, what’s with the new found optimism?  Fundamentally, the overly pessimistic assumptions baked into valuations have not come to pass in the fourth quarter results.  Mind you, the results themselves were not spectacular, only that they were much better than what was assumed.  Two, with historically low interest rates globally, valuations have to go up (discount factor has gone down).  Three, GDP numbers are looking to be in the 8% range in the year ahead and not 6.5 to 7% as was previously thought – borne out presently by good IIP and capital goods purchase data.  That said, all of these data points were available and positive even two weeks ago, so why the great rush now? 

There is an old saying: ‘Don’t fight the Fed’, so when Bernancke pointed to ‘green sprouts of recovery’ investors took notice.  Once this reversal started, it began to be seen as what it really was – cheap global capital trying to find a home.  More importantly for India, this capital will chase returns in economies that can still grow at 7% plus.  So, there was an influx of large capital being deployed in India in a short period of time, which has created this rally.  Now, once others saw the strength of this rally they did not want to be left behind further stroking the fires. 

Will this rally sustain?  At current levels, for the very near term, the market has more profit taking risk than upside potential.  That said, the capital deployed is real and so are the fundamental drivers and so the overall trend from here is positive.  If anything, a lot more investors have began to take notice and will likely look to enter the market now.  That can also mean that the golden entry point that we have all been looking for in the post-poll dip may actually not be as stellar.  The current rally is reflected in a multiple expansion which accompanies large capital deployment and is characteristic of an abrupt change in sentiment.  Conviction in the rally will come from further validation of fundamentals, mainly the next quarter results.   

It is critical, then, not to lose sight of valuations and gravitate towards high beta, mid-cap stocks, if you are a long term investor.  You should very clearly also be looking to increase your equity allocation to 60-70%, bringing down debt.  The new economic cycle has well and truly began and equities will outperform all other asset classes from here on out for the next 18-24 months.  We like Banks, Capital Goods, Power and Auto Components at this point.  IT, FMCG, Pharma and Realty will take some time to catch up.  Focusing on specific stocks based on economics will offer the best results.  You can look at our detailed recommendations in iMPlayBook, for a diversified portfolio of stocks that are poised to make the most of this rally.