Dalal Street is waiting for new triggers to continue the rally. Valuations in the banking and financial space, which has been the leading the rally, has reached its all-time high limiting further upside in the near term. Top companies in underperforming sectors such as IT, consumer goods, oil & gas, power, telecom and metals should start firing to take the market to new highs, market players say.

The country’s top 15 banking & financial companies are now trading at a 10-year high valuation of 18.1 times their trailing earnings and 2.3x their latest book value. Financial stocks together now account for 30% of the Nifty 50 index, up from 24% a year ago and the  previous high of 27% in March 2013. Some in the sample includes the State Bank of India, ICICI Bank, HDFC, HDFC Bank, Axis Bank, Punjab National Bank, Canara Bank, Bank of Baroda, Yes Bank, IndusInd Bank and IDFC among others.

The Bank Nifty index is up 55% in the last 12 months, outperforming the benchmark Nifty that is up 33% during the period.

Further upside is limited in financials from current level and other heavy weights in sectors such as oil & gas, capital goods and metals should start contributing to take the rally forward, says a senior analysts with a brokerage house in Mumbai. Such a high exposure to a single sector is a risk to the market in the near-term as a correction in the stock prices of banks and financials would pull down the overall market even if other stocks do well, he adds.     

In the past, these peak has always been followed by period of under-performance by the bank and financials stocks. Overall however, financials have been out-performing the broadermarket since early 2007 resulting in a steady rise in thier index weightages. In March 2006, financials accounted for 17.6% of the Nifty companies combined free-float (non-promoter) market capitalisation.
Others says that financials and other high beta could be be hit first if the foreign capital inflows in India slowdown. Banking and financials stocks have been the biggest gainer of strong FII inflow in India. If the trend reverses or of the flows moderate, if could adversely affect the valuation in the sector and pull the broader market in the process, says Dhananjay Sinha, head institutional equity Emkay Global Financial Services.

Pharma companies have also been a net contributor to the market rally in the last one year out-performing the broader market. NSE Pharma index is up 63% in the last 12-months helping Nifty make a new high during the year. Country’s top four pharma companines that are part of the Nifty now account for 6.4% of the Nifty 50 index up from 5.9% a year ago and 2.3% five years ago.

Anaylysts attribute this to strong operational and financial performance by Indian pharma companes on back of higher exports to United States. The steady rise in the share price over the last five years has pushed valuiations in the danger zone raising the prospect of a correction if the capital inflows slowdown.

Bulls however say that there is no limit to how much a sector can contribute to the market rise and there is further upside in out-performing sectors. Banks and NBFCs are proxies to the economy and their financial performace would only improve from here given the likelihood of a pick-up in capex cycle and GDP growth, says Devang Mehta, senior vice president and head equity sales, Anand Rathi Financial Services.

Other are banking on the continued good show by the services sector. India is a service sector oriented economy and this segment continues to do well despite difficulty in the industrial sector. Financials are a good proxy for the growth of the India’s service sector. I expect bank and financials to lead the market going forward, says G Chokkalingam, CEO and founder Equinomics Research & Advisory.

Even the bulls are right, market rising dependence on financials to scale new highs does raises few questions and investores are better off hedging themselves against a sell-off in the sector.