Stock market outlook: Tread cautiously as markets surge to new highs

Last week there were two incidences that indicated euphoria being slowly setting in the Indian market. The first was the launch of a five-year close-end Sundaram World Brand Fund. The fund house is raising money from investors to invest in world's strongest brands. The fund house is said to have appointed three brand consultants that would rank the world's top brands and then it would choose the common names from the three lists to invest in the equity of the top branded companies in the world. When the going is good, mutual funds don't miss a single opportunity to exploit the sentiment of retail investors by showing them the carrot.

Between November 14, 2013 and November 13, 2014, International Funds have eroded capital of investors. International Funds have delivered returns between a negative 20 per cent and a gain of 24 per cent. The ones that have returned more than 20 per cent had 30 per cent exposure in Sensex stocks. On the other hand, large-cap funds have reported a minimum of 18 per cent return to a maximum 56 per cent.

On one hand, the market regulator the Securities and Exchange Board of India doesn't miss an opportunity to criticise the mutual fund industry on its performance and how they aren't being able to attract investors, on the other it allows mutual fund to come out with high-risk funds when the market is at an all-time high. Rather than benefiting the industry, such funds could damage the image of the entire industry as investors in India still don't understand the risk of getting into equities. While the mutual fund industry in October saw record inflows, when you speak to distributors and financial advisors you realise that existing investors who have made money are pumping in more funds on hopes that the market will continue to surge. The new set of investors is still not being pulled towards mutual funds or the equity market.

In terms of valuation, the Indian equity market is fairly valued with the benchmark index trading at 15 to 16 times one-year forward earnings. In fact, the market has already discounted positive factors and there has been a considerable price-to-earnings re-rating in the market. The market will wait for earnings to catch up before the next surge and it could take seven to eight months for earnings to improve.

All eyes will be on the government and its initiatives to boost economic growth. In the next 15 days we will also come to know the mind of the Reserve Bank of India (RBI) and its outlook on inflation and interest rates. The big trigger will be the reform programme and spending from the government in sectors like infrastructure and power. Until then it would be advisable for investors to tread cautiously in the market, which is starting to look euphoric, and past experience suggests players burn their hands in such scenarios.

Meanwhile, global cues will dictate the trend in the Indian market this week. US President Barack Obama's meeting with Russian President Vladimir Putin amid tensions over Ukraine and Russia will be keenly watched.