Stock market returns have been truly spectacular since the 2000 March crash. The global rally has enriched millions of investors. In 2021 India has been an outperformer. A unique feature of this rally has been its one-way up move, without any major correction. This trend has been broken by the correction in November, particularly the 2.7 percent correction in Sensex on 22nd November.
India has been the best performing large market in 2021 till early November making valuations stretched. At rich valuations, markets are vulnerable to corrections. The trigger for correction came from multiple sources – RBI’s caution on stretched valuations, foreign brokerages downgrading India, sustained selling by FIIs and the disastrous listing of Paytm. Now, a major concern for global markets is inflation, which is at a 30-year high in US. But the Fed still believes that inflation is transitory and not structural. The US central bank has been reiterating that since the recent spurt in inflation is due to supply bottlenecks and not wage-hike driven, it will be transitory. If the Fed is proved right, the equity markets are likely to remain resilient. On the other hand, if inflation turns structural, bond yields will go up impacting stock markets.
The trend in the US 10-year bond yield would be the important variable to watch. The recent high in the 10-year yield is 1.74 percent and now, in November, it is hovering around 1.6 percent. If it hardens and goes beyond the recent high of 1.74 percent, that can trigger a sharp correction in global equity markets. On the contrary, if the bond yield hovers around the present levels, the markets may continue to be resilient.
Since valuations continue to be rich the market is unlikely to surge ahead. If negative triggers like sustained rise in inflation and bond yields do not materialize, markets are likely to move into a phase of consolidation and sideways movement. It is important to understand that even in the consolidation phase, some sectors and stocks will do well, and some will languish. Smart investment would be to identify the sectors that will do well even in the consolidation phase. Here, trends in sector rotation provide clues. Every bull market has its leaders. From the current trends, it appears that IT, which has been doing exceedingly well, would continue to be the leader in this rally. Globally, IT is doing well and the accelerated digitization after Covid outbreak has improved the prospects for Indian IT companies. There are clear indications of a multi-year expansion cycle for the IT sector and the valuations, though high, are not stretched unlike in many other segments. So, it makes sense to remain with this leader of the rally.
Active participation of retail investors in this rally is a very desirable trend. DIIs plus retail investors are now a force to reckon with in the Indian market. Earlier, whenever FIIs sold heavily, markets used to correct. Not so now. Sustained selling by FIIs has not dented the market, so far. Foreign Portfolio Investment is ‘hot money’ that moves in and out influenced by global macro triggers. Domestic money – DIIs and retail – emerging as a counterbalance to ‘hot money’ is a healthy and desirable development. But retail investors should exercise some restraint in their trading activity. There is excessive day trading and speculation by newbie investors in the market now. This is more likely to lead to losses than gains. So, investors should focus on investing rather than trading.