India market euphoria could end in disappointment
Indian equities leapt to a record high on Monday amid euphoria over the opposition Bhartiya Janata Party's (BJP) success in state elections; however, strategists say investors' enthusiasm should be tempered.
While state elections provide a barometer on the mood of the electorate in the run-up to nationwide elections scheduled to take place by May 2014, experts cautioned not to extrapolate the results to a nationwide level as they are not always a reliable indicator as recent history has shown.
For instance, in 2003, the BJP had performed well in the state elections, but lost the national elections held a few months later in 2004.
(Read more: Why India's state elections matter)
"We think that chasing the rally is not prudent, as it remains to be seen how the incumbent party will react to its poor showing in the state elections," Nomura strategists wrote in a report on Monday.
"The possibility of the ruling party abandoning its commitment to fiscal consolidation – the year-to-date fiscal deficit is already running well-ahead of budget estimates – is worrying. If this occurs, then the market will likely drift down after first pricing in state election results," they added.
State election results announced on Sunday revealed the BJP secured an absolute majority in three out of the four states - Rajasthan, Madhya Pradesh and Chattisgarh - and a plurality in the fourth state - Delhi. This sent the benchmark BSE index rising as much as 2.3 percent to a record high of 21,483.74 on Monday, surpassing its previous all-time peak hit on November 3.
The BJP, led by Narendra Modi, is perceived as more business-friendly and willing to implement reforms compared with the ruling Congress party, which has been tainted by poor economic performance and slow pace of legislative changes.
Nomura said it is sticking with its end-March 2014 Sensex target of 22,000 – which is around 3 percent higher from current levels.
Andrew Holland, chief executive of Ambit Investment Advisors also believes enthusiasm towards Indian equities should be moderated.
"I wouldn't read too much into what we saw in terms of the mood overall for India. You have to remember this is only 13 percent of the overall seats which they have won, and 14 percent of the total voting population," Holland said. The 4 states which held elections represent 72 out of 543 seats in the national Lok Sabha – or the lower house of parliament.
"I'm a little bit skeptical that you can really look six months out and say that there won't be changes. I'm sure Congress will want to come back very strongly, it could well be that they'll start to throw their heavyweight politicians behind their movement in the six months," he added.
Avadhoot Sabnis, analyst at CIMB, said he is maintaining his 12-month target of 6,000 for the Nifty index, or 6 percent lower than current levels.
"We believe it is too risky to take positions right now for any outcome given that it has been difficult to predict the outcome of national elections," he said.
—By CNBC's Ansuya Harjani; Follow her on Twitter: @Ansuya_H