The Indian market may not hold up in the next 2-3 months unless we see an improvement in macro factors and an end of policy paralysis in India, says Kotak institutional Equities in a strategic report on the Indian equity markets. According to the note, the market is already discounting positive events in the next 2-3 months with most largecap names trading at rich valuations, but is ?largely ignoring the risks from continuous policy drifts?.

Kotak believes that the current stock prices are already discounting improvement in macro factors and an end of policy paralysis. ?Fair valuations of the Indian market and rich valuations of some of the largecaps in our view are already discounting improvement in these two key headwinds as well as continued largesse of global central banks which would result into lower cost of equity globally,? it says.

Currently, the Indian market is trading at a forward multiple of about 13 times against a historical range of 12 to 16 times. However, in the context of other emerging markets and its historical range the Indian market is not particularly cheap reckons Kotak given that earnings growth has slowed down and return metrics have corrected considerably. The brokerage house expects earnings growth of BSE-30 index to stand at about 10% in 2012-13 and at 11% in the following fiscal ( FY14).

According to the report, Kotak is not comfortable with valuation of most largecaps including high-quality defensive stocks and others for which the market is largely ignoring potential risks. However, the brokerage house is more concerned about stocks from the latter category, for example capital goods stocks like L & T which in its view are already factoring in pick-up in investment cycles, or banking stocks that are reflecting no further deterioration in NPLs. It opines that investors may lock in gains even in some of the government owned energy companies, whose prices are already factoring in an increase in fuel prices and banks and utilities stocks which are pricing in problems in the power sector.

The report lists down four key reforms that may be critical to support the market?s valuations and shore up investment sentiments. These include reforms related to Taxation (implementation of GST), Subsidy (fuel price hike), power sector ( through its impact on the NPL levels in the banking sector) and investment (FDI and FII investors? confidence about Indian economy and taxation policy).

It argues that if the government fails to push through some of these reforms over the period of next 2- 4 months, India may have to wait for another 18 to 21 months for further economic improvement to follow-through as India faces several state elections over the next one and a half years as a prelude to the national elections in May 2014.