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BSE’s benchmark index, Sensex, rose above the 50,000-mark for the first time ever on Thursday. Hopes of more stimulus from the newly elected US government have aided sentiment. US treasury secretary nominee Janet Yellen’s comments that, despite high national debt, policymakers should not refrain from major stimulus have added to the optimism. One view on the Street, then, is that the high liquidity that has driven the markets to record levels will help sustain the rally as well.

Indeed, the latest global fund manager survey by BofA Securities showed that 19% of respondents were taking higher than normal risk.

However, liquidity is fleeting. “Value endures. Prices driven only by liquidity don’t. The liquidity tap is gushing now, but can go off at any time without warning. Investors need to be mindful of this risk with valuations at record highs," said Bharat Iyer, a senior market analyst. “The rally in small cap stocks is also disconcerting, with sharp spikes in some counters without any change in fundamentals."

The BofA survey lists some other risks that can play spoilsport as well. Global fund managers foresee three new tail risks for the markets. Covid-19 vaccine rollout, or the pace of it, tops the list of tail risks, followed by the possibility of a “tantrum" in the bond market, said the survey report. Inflation continues to be listed as a risk.

Despite Indian equity markets trading at expensive valuations, investors remain complacent
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Despite Indian equity markets trading at expensive valuations, investors remain complacent

“Expectations are that the second half of the year will see a significant increase in activity indicating that companies are factoring in a successful vaccination rollout, which naturally makes it a key downside risk for markets if governments fail to successfully roll out the vaccines," analysts at Saxo Bank said in their latest blog.

Even though BofA survey respondents see better prospects of a global economic turnaround, they feel that the Goldilocks scenario of higher growth and lower inflation has peaked.

In fact, a record net 92% of those surveyed expect higher inflation in the next 12 months.

Analysts are also wary of the valuations at which global equities are trading. Valuations of Indian stocks are racing ahead even relative to others. The MSCI India index is trading at a one-year price-to-earnings (PE) multiple of 30 times, a significant premium to MSCI Asia Ex-Japan, which is trading at 18 times. As valuations are a function of earnings, corporate earnings growth has to be solid to support this multiple, analysts said.

“With the strong market rally, valuations are looking elevated on various parameters (be it price/earnings, price/book, market cap to GDP). Therefore, with valuations reaching optimization, returns may be subdued in the short term. The easy liquidity scenario globally is expected to support valuations for some time, though any change in stance could lead to market volatility," said Sampath Reddy, chief investment officer at Bajaj Allianz Life Insurance.

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