In the last one-year, Indian equity market has doubled, triggering anxiety about future performance. Many have started to book profit and reduce their exposure in equity. Selling by Domestic Institutional Investors (DII) and retail investors is noticed, especially through MFs. Investor sentiment remains cautious and volatility has increased, during the year, as expected. The high valuation of the Indian market is presumed susceptible in the short-term. Well, it is possible that we could even have one or two jolts in the rally due to rising crude prices, inflation and bond yields.
All of these concerns are valid and it is true that very high returns cannot be expected in the short to medium term. But on a positive note, that does not mean that equities have become very risky, because the economy is on course to high growth and impressive corporate profits. The economy is moving towards normalcy, which is the main reason for the increase in cost of commodities, inflation and short-term interest rates. We can still expect good returns in the medium to long-term. So, hold on to quality stocks.
At this juncture when there are rising concerns over the future market movement, let us not talk about the positive factors that would help the market to sustain and provide returns in 2021 and 2022. Most of those reasons are well-known and have been discussed continuously in our monthly magazine. For example, last month we deliberated about the upside in domestic capex and consumption, and support from the expansionary budget. We all know that Indian real GDP growth is expected to be buoyant in FY22 in the range of 11% to 13%, which limits economic risk.
Here we discuss the main gray areas that concern investors about the future performance of the equity market:
1. Rising Crude Prices: Indian market is sensitive to increase in crude prices as historically we have been importing about 80% of total domestic fuel requirement. This directly impacts consumer inflation and profitability of companies. As a result, we have negative correlation with rising international oil prices. But we should not be too concerned because it is noticed that Indian market underperforms only during the short-term i.e. the correlation is effective largely during sudden rise in crude prices. Domestic market continues to perform better on a medium to long-term basis by adjustments in excise duty and fall in long-term international prices. Importantly, the future relativity of India’s equity market to movement of oil prices is expected to further reduce given aggressive plans of increasing local oil and gas, renewable energy and increase in ethanol fuel. The global demand for crude is also on a long-term negative trend due to strategic development of green energy. India has an ambitious target to increase renewable energy to 40% of total power capacity by 2030. As per Niti Aayog, 70% of commercial cars, 30% of private cars, 40% of buses and 80% of two-wheelers sales in 2030 will be EV. International crude prices are expected to be on a downside trend on a long-term basis.
2. Will liquidity sustain? It is presumed that major part of the rally of the last one year was supported largely by easy money policy, especially the US bringing new money to EMs like India. Well, we should also notice that this new money addressed the recession and helped the economy to recover quickly to pre-Covid levels. Today, the economy is on a recovery mode, we may not need further stimulus. So, a drop in stimulus is expected and this will not have a catastrophic effect on the stronger economy and stock market. In the recent policy meet, FED categorically stated that it would maintain an accommodative and low interest policy for a long period of three years.
3. Risk of rising NPAs: Even though the economy has recovered well, the debt in the system has increased. True that this should be the biggest risk for the economy, especially for banking sector in the coming 2-3 years. The high level of debt may not be generating enough revenues today, as it is mainly used as a support and survival for industries. The ability to service debt may be low today and it has to improve in the coming 2-3 years. In India, moratorium, government loan guarantee and new loans provided to MSME and industries, are under standstill (cannot be considered as NPAs as per SC order). If we adjust that the actual level of Gross NPA in the system, will be very high. This will impact government and PSUBs, more than private banks, if their business does not survive and grow in the future. Currently the Government and RBI are very supportive, not affecting the financial market. Long term economic recovery and strategic measures can ensure the soundness of the banking system.
4. Rising global and domestic inflation and bond yields: Inflation is an inherent requirement of a strong economy. And inflation is the core requirement for this pandemic hit world economy, to generate growth and to survive. Inflation has to be maintained above the normal level for some more time. During this high inflation period, central banks will maintain an accommodative stance and low bank rate. As expected, the short-term interest rates are rising and are volatile. This will be normal in an uncertain world of second wave of Covid, rising inflation and debt in the economy. We are bound to be in a scenario of rising inflation and short-term rate, which will help the economy and corporates to sustain and generate revenue. We should not panic.
5. High Valuation: Yes, the valuations are high which will check the market for further upside. At the same time, the high P/E is also due to low base of earnings and lack of ability to forecast the near-term bounce in demand and supply. In the last three quarters, we are continuously witnessing positive surprise results leading to further elevation in earnings forecast. Market is responding positively to this. This trend may continue in FY22 too, given strong upside in economy and supportive government policy. This is a period where valuation parameters like P/E may not be the best indicator to assess the level and trend of market. We are bound to be at premium valuation levels.
We believe that the market will maintain its positive bias on a medium to long-term basis supported by surge in economy, low interest and reforms. We may have volatility in the short-term given solid gains made by stock market and confusion regarding interest rate movement in the short-term along with high debt in the economy.
We presume that this is a buy on dips market. If we look at the performance of top 500 listed stocks in India, consolidation has started. As per the data of Nifty500 index, dated 18th March 2021, about 45% of stocks are below or equal to 15% from 52wk high. This phase of consolidation can prevail in the short-term and any further correction should be used to add stocks. The best stocks and sectors to own will be like Green energy as solar, EV and Hydro (private). New technology services in digital, pharma and chemical too are looking good. Old economy sectors are also expected to perform well due to return of growth. Debt free companies, industrials, auto, metals and infra can do well in 2021-22.