5 graphs show why the $220-bn Indian stock market rally may be overheating

Just a few weeks ago, Indian stocks suffered from their worst run of losses in almost eight years, diverging from their broader Asian and emerging-market peers. Election uncertainty, rising oil prices and tensions over Kashmir were blamed.

Fast forward to now and the S&P BSE Sensex Index has rebounded 8 percent, with the once-stacked wall of worry taking second place in investors’ minds. The gauge has gone from being one of the worst in Asia last month to the best, as the market has regained almost $220 billion since a low in February. Foreign investors came flooding back, with more than $3.8 billion of inflows in March alone -- set to be the most in two years.

Is this too fast too soon? Perhaps. After an eight-day rally -- its longest winning streak since July -- the Sensex slipped 0.6 percent on Friday.

“While some of the domestic/global uncertainties may have abated, one still needs to be watchful,” Citigroup Inc. analyst Surendra Goyal wrote in a report published March 20. An index by the firm that tracks sentiment suggests a neutral stance, the note said.

The upcoming elections have also kept some at bay. The world’s biggest democracy is about to begin six weeks of voting that will decide whether Prime Minister Narendra Modi wins a second term, with the final results due on May 23.

“We have to wait until the election is over,” said JPMorgan Asset Management Chief Market Strategist Tai Hui at a press briefing in Hong Kong on March 21. “The election results can swing the market quite violently. I’m quite happy to sacrifice a little bit and move into India when the results are out.”

Here’s why some market watchers are skeptical in the short term:

The market has been in overbought territory for the past eight days, signaling the gains might have come too quickly to hold. The last time the Sensex hit such levels last August, it plunged some 14 percent in less than two months.

Another sign that the nation’s equity surge could be reaching its tipping point is that the index is now around 5 percent above its 50-day moving average. The last two times the divergence reached such levels -- in the summer and at the beginning of last year -- the market slumped.

Greed dominates India’s stock market now more than any time since 2009, according to a Bloomberg indicator. The so-called fear-greed index on the weekly chart for the Sensex shows pessimism has turned into bullishness in less than half a year. Extremes in both trading impulses rarely last long, and this exuberance may give traders reason for caution.

Indian equities aren’t cheap. Despite the weakness earlier this year, they’re still trading above their five-year average. Relative to emerging-market peers, their valuation is more than 50 percent higher.

But, maybe, in the longer term, there’s something to get bullish about:

Fundamentals of corporate India are improving. Analysts’ average profit estimate for Sensex companies in the next year has jumped to a record high -- not just in rupee terms, but also in U.S. dollars. When volatility driven by politics settles, the earnings picture may provide support for gains in the Indian market.