Sensex may hit 25,000 on stable government: Macquarie

Indian stock markets are trading at record highs, with the BSE Sensex scaling the 22,000 peak and the Nifty climbing above the 6,600 levels for the first time. However, retail investors have not participated in the current rally. Markets have moved up primarily on account of strong flows by foreign institutional investors. Rakesh Arora of Macquarie Capital Securities told NDTV's Prashant Nair the retail investors should not shy away from the current rally as bigger gains await markets once a stable government is in place post elections due in May.

Mr Arora makes a strong case for further upsides in Indian stocks and tries to dispel some of the doubts about the current rally. Here are the edited excerpts,

How are valuations stacked up?

Indian markets are trading at 14.5 time 2015 earnings, which is the 17 year average. A stable government post elections will lead to a re-rating, and valuations may climb to 17-18 times earnings. So, there's a lot of room for the market to go up. Another 15-16 per cent could be pretty easy in next few months.

We are not building any kind of bubble here. In no way we are building in too much optimism. In last 5 years we were trading in a narrow band and now we are gradually coming out of this band, so it is nowhere near the typical market high.

What will happen if a fractured mandate comes in election?

Only 20-30 per cent of election results have been discounted in markets as of now. 70 per cent of the current rally is driven by the fact that Indian economy is bottoming out and actions taken by the government to control current account deficit, fiscal deficit and inflation has paid off. Huge amount of projects has been cleared by the Cabinet Committee of Investment. All these things taken together led to positive contribution to market.

From here on, more eyes will be on election for the next two months. There is a 70 per cent chance of an NDA government coming to power. Market is not above 7,000 because there is still some worry about NDA coming to power. Markets may have a knee jerk reaction if things are not favourable and then follow the economic trend.

We need to give to the credit to the present government that despite elections round the corner they have not gone for populous measures. Last 15-18 months they have really done lot of things in terms reforms, etc. The new government will have the benefit of these reforms. Things have not picked up on ground as yet because of the uncertainty but these decisions are in place and once the sentiment improves things will start happening on ground.

What will happen if US does not recover?

If the Federal Reserve is confident of cutting the stimulus it means that they are confident that the US economy will recover. The consumer confidence data, which came on Tuesday, is at 6 year high, so that is pointing out to recovery.

Within emerging markets, India seems to be doing much better vis-a-vis other emerging markets. People believe that Indian problems are more internal rather than global, so they can be rectified in a short period of time. That is why India is getting preference over China. We are seeing a shift of money from China to India. India is still growing at 4.5-5 per cent, which is not so bad from the context of global growth. All these things combined are adding to the euphoria.

Top bets: Domestic cyclicals are what investors are focusing in. We are seeing a churn from export oriented sector i.e. IT, Pharma to banks, cement, industrial, etc. L&T, Axis Bank, ICICI Bank are top three recommendations.

PSU companies are looking at decade low valuations; if buoyancy comes to economy then these names are better placed to take advantage because they have been expanding even in the down turn.