Indian Stocks May Not Have Turned Corner Even After Tax Cuts

(Bloomberg) -- India’s surprise cut to corporate taxes to one of the lowest rates in Asia triggered the biggest surge in stocks in more than a decade. Yet, some equity technical indicators may show the gains could be fleeting.

The benchmark S&P BSE Sensex rose 5.3% on Friday, marking its biggest gain since May 2009, after the government unexpectedly slashed the corporate tax rate on domestic companies to 22% from 30% to bolster economic growth.

"These measures would increase the chances of a higher fiscal deficit and the government may have to resort to spending cuts or embark on higher disinvestment," said Arun Thukral, chief executive officer at Axis Securities."However, focus on liquidity and economic revival was much-awaited in the current scenario."

Apart from concerns about a widening budget deficit and that the $20 billion tax cuts may only provide a one-time boost to markets, stocks in Asia’s third-biggest economy also face challenges including expensive valuations, an exodus by overseas funds and some ominous technical patterns.

Here are three charts to keep in mind.

India’s benchmark S&P BSE Sensex 1-year forward price-to-earnings ratio is at a 6.5% premium versus its 10-year average, making it the most expensive bet among emerging Asian equities, according to data compiled by Bloomberg.

Tax cuts "will certainly boost India’s earnings, cash flow and attractiveness from a medium-term perspective, we believe turning around business cycle could still remain challenging," Edelweiss Financial Services Ltd. analysts including Aditya Narain wrote in a note on Friday. "The current economic constraint is demand shortfall, whereas today’s measures amount to supply-side push."

Foreign investors sold $4.9 billion of local stocks this quarter through to Sept. 18, which would be the biggest quarterly outflow since at least 1999. The Sensex Index’s
biggest one-day gain in a decade on Friday was able to attract only 357.8 million rupees ($5 million) of foreign inflows into Indian stocks, according to provisional data from National Stock Exchange.

The benchmark Sensex formed a so-called “death cross” where its short-term average dipped below a longer-term average on the day before the surprise tax cuts. The indicator is seen as a harbinger of further declines. The index had also entered a correction that day after falling 10% from a record high reached on June 3.

India’s benchmark indexes have made a U-turn but they need to "sustain above" their 200-day moving average to confirm a positive bias, Prabhudas Lilladher Pvt. analysts wrote in a note on Friday.

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