In 2020, consider the paradox of the equity market, as COVID cases increased equity rallied too, after an initial jolt. The rally was backed by financial support & economic rebound. Today, the rally is carried more by financial measures than economic activities. Historical valuation suggests that the broad market is ahead of its intrinsic value. If that is so, in 2021 when COVID cases reduce sharply, as vaccination grows, will the equity market correct, too, as financial support reduces?
That notion may sound weird on economic terms, as the world economy is bound to grow substantially in 2021 & 2022. Indian GDP is expected to grow by +10 percent in 2021. A rationale for equity to follow through. This will be especially positive for left-out sectors, which were heavily impacted by economic slowdown triggered by COVID; cyclical sectors like Metals, Mining, Infra and Oil & Gas.
It will also be a boom for services & discretionary sectors like entertainment, travel, tourism, hotels, aviation, auto and durables. So, we should expect these beneficiaries to lead the equity market in 2021. But as we all know, today even the broad market is considered as supremely priced.
We need to know how much of this is factored in these sectors. If we look in to the performance of such sectors in India, they all have rebounded nicely after the first jolt. In that the best return is in Metals, Auto and Realty. The weakest are PSU, PSUB, Media, Energy and Infra, on an average up by 66 percent from year low.
A good learning from the pandemic is that, in the long-term, the weak companies will move out unless they absorb new norms of business. The stocks and sectors, which we may conclude as a value buy may enclose the inherent weakness in their business model. They may not survive well in the future and underperform.
It is very difficult to find stocks and sectors trading below the intrinsic value. Within that we see value in Banks, PSUs, Infra and Metals, but stock specific is the key to capitalize from it. Such stocks and sector will do better in 2021 compared to 2020, but volatility is bound to stay. On stock specific basis mid & smallcap, too. On a historical basis though IT and Pharma cannot be considered as a value idea, considering the outlook, they have a good chance of further re-rating.
Market refers to this rally as a liquidity driven momentum. This liquidity, which was boosted in the second half of 2020 by fiscal & monetary measure, will not dry out soon. A new stimulus, though smaller than the first one, is just announced in the US. Similarly, the next set of measures is expected to be announced in other developed nations in 2021.
Central banks are expected to hold the rates low for a long time, till the employment rates get to pre-COVID levels. For example, in US unemployment rate is 6.7 percent compared to 3.5 percent in February 2020. The size of fiscal & monetary package in the future will get smaller, but the benefit will be good enough considering the bounce in the economy & earnings. It will maintain a positive environment in the equity market.
In the near-term, there are some concerns. In the world, the liquidity driven rally, can be impacted by any rise of global risk. In India it is the flow of FIIs funds, which is at its best ever in the last 3 months. At the same time, we see that smart money in domestic institutions and MFs are booking profits and shifting from equity to debt. Sustenance of FIIs money is the biggest risk today as any global risk will ignite funds to go back from emerging markets (EMs) to home country. Currently this outflow is not visible based on the trend of debt market. The 10-year yield of the US is still stable and low below 1 percent, though it has increased by 0.50bps in the last 6 months. Premium level of equity market makes it the most vulnerable for any change in trend.
An important event factor for India will be the Union Budget of 2021. Importantly, the government should relax the FRBM fiscal target for the next two years, given the pandemic. In-spite of low government revenue income and weak fiscal position, capex expenditure should be increased, which is at the lowest today. India should maintain the reformist agenda, which was the main factor to provide an edge to India in-terms of FIIs inflow and stable currency, compared to other Asian peers, in 2020.
Inflation in India continues to be rigid, it is very high even when the economy is slow. As on November, CPI was 6.93 percent, average during the year is 6.81, while RBI bank rate is 4.0 percent assuming long-term inflation target of 4.0 percent. The possibility to achieve that seems dim today as economic activity is expected to rebound in 2021. The target of 4 percent is possible only by structural reforms, like getting real benefit of new agriculture act and subsequent fall in food prices. It is also possible by cutting excise duty on fuel on which the government is surviving today as an important income and also has to consider to promote renewable energy. These factors seem muted in the short to medium-term. RBI will be forced to hold rate low for a long-time in spite of high inflation and risk of NPAs to rise in the future.
Experts are of the view that NPAs of banks will witness a surge in 2020-21 amid the COVID-19. Pandemic will flush out weak business in the future. Many borrowers who have availed moratorium & restructuring can shift to NPAs in 2021 onwards. RBI has acknowledged the issue and expects NPA level to increase from 8.5 percent in March 2020 to 12.5 percent in March 2021. Pessimists presume that rate to hike to as high as 15 percent. This is a factor why Indian banking stocks have rebounded weakly compared to other sectors. Private banks are performing the best in the sector followed by NBFCs and PSUBs. If this really happens in 2021, yields will rise triggering risk-off in the domestic market.
We have a target of 14,500 for Nifty50 in December 2021, which shows a moderate view on a YoY basis. This target is based on a very high one-year-forward P/E of 20x, expecting high double-digit growth in earnings. Nevertheless, the target has upward bias due to economic development possible in 2021 based on the progress of vaccination and fiscal support. Today, the main indices target may show a vague outlook, but we expect the broad equity market will benefit from the dual effect of high liquidity and earnings growth. In that we can expect Mid & Small caps to outperform the main indices. Importantly, the easy fiscal and monetary policy should be maintained in the world, as seen in 2020, which is possible as the level of employment is still low.
Article first published in moneycontrol.com
