The Sensex set a new record on Wednesday, closing above 14,000 for the first time. The bull run in the last few months has enthused investors, and even sceptics — who have been warning that the market has become overheated — have started to sing a different tune. Market sentiment is very bullish as local operators have been buying in anticipation of fresh positions being taken by foreign investors in the Indian market in the new year. The recent jump in advance tax payments is an indicator that third-quarter corporate results should be good.

Going forward, however, there are several headwinds. The most pressing one is the prospect of higher interest rates, as the Reserve Bank of India clamps down on money-supply growth in an effort to contain inflation. Banks have already started raising lending rates and this could have an impact on consumer credit offtake. At the same time, it is worth remembering that salaries have been rising sharply in many industries, and that could offset the higher interest payments that buyers of homes or consumer durables have to make. Moreover, if oil or commodity prices were to fall further because of the expected slowdown in the global economy then that would also bring down inflationary pressures, which would ease the pressure on the RBI. In these days of globalization, much also depends on the world economy. Almost everybody is agreed that the United States of America will see a deceleration in growth. Consumer spending in the US has so far not been much affected by the weakness in the housing sector, and most bets are on a soft-landing for the US economy. Others point out that even if the US slows down, the European Union and Japan will make up for it. In other words, investors are hoping for a continuation of the not-too-hot, not-too-cold Goldilocks global economy of the last few years. The outlook on the liquidity front is also benign at the moment. Japan is in no hurry to raise interest rates and the tightening cycle in the US is over. Analysts have warned, however, that a slowing US economy could lead to a deceleration in the flow of funds into the markets. Given the importance of inflows of foreign institutional investment to the Indian market, any slowdown in that regard will be very damaging. The biggest concern has been the stretched valuations of Indian equities, which have led to more money flowing into other emerging markets like China in the recent past. The third-quarter corporate results in the next few weeks will show whether these valuations can be sustained.