"The markets are going up on the back of liquidity. Till the time there is easy liquidity, markets could keep going up. However, we have to be mindful of stretched valuations. Street is hoping that there will be sharp recovery in earnings of 15-18 per cent. However, it hasn't reflected in the first quarter numbers," said Daljeet Kohli, head of research, IndiaNivesh.
The benchmark Sensex now trades at 16.5 times its 12-month forward earnings expectations compared to 12.5 times for the MSCI Emerging Markets Index. Sensex valuations are highest since April 2015, as per Bloomberg data.
Both domestic and foreign institutional investors (FIIs) were net buyers to the tune of Rs 485 crore and Rs 391 crore respectively.
"Most mutual funds are dabbling in midcap and smallcaps which is driving up their prices. Foreign funds and ETFs are mostly investing in the main indices. We are seeing action on both sides," said Deven Choksey, managing director, KR Choksey Investment Managers.
Consumer discretionary stocks were the biggest gainers on Tuesday in anticipation that the government may disburse Rs 34,600 crore to its employees in August salary as Seventh Pay Commission arrears. Bajaj Auto gained 3.4 per cent, Asian Paints added 3.2 per cent and Maruti Suzuki rose 2.8 per cent.
Deutsche Bank in a note said two-wheeler companies and banks would be the main beneficiaries of the implementation of the 7th pay commission.
"India looks set for a positive confidence shock, which should boost consumption and help buoy domestic aggregate demand robustly," said Deutsche Bank in a note.
Experts said markets have come to terms with the rate-hike in the US. The US Federal Reserve last week had said that the case of interest rate tightening in the US has strengthened but hinted that any increase would be gradual. The US nonfarm payrolls data due Friday will be keenly watched by the markets as it could determine Fed's next move, said analysts.
The Sensex is up 23 per cent from 2016 low of 23,000 touched on February 29. The rally has been fueled by robust foreign inflows. FIIs have invested nearly $6 billion into Indian stocks so far this year.