‘Market over-valued but economic indicators improving; invest in these 4 safe sectors’

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It makes sense to remain invested in this bull market. At elevated valuations, corrections can happen any time. Investors should opt for a strategy that minimises the impact of a sharp correction.

The steady decline in fresh COVID-19 cases and improving recovery rate has become a distinct trend since early June, a clear indication that we are bending the coronavirus curve.

The improving situation has already paved the way for the lifting of restrictions in several states, including economically significant Maharashtra.

Globally, too, there is good news from the developed world where vaccination is progressing well and the pandemic is coming under control. These trends augur well for the global economy, which is expected to bounce back to 6 percent growth in 2021.

What are the prospects of India’s growth and corporate earnings in FY22?

India’s GDP contracted by 7.3 percent in FY21. The pain has been acute in the MSME and unorganised segment, which bore the brunt of the coronavirus-triggered lockdowns and restrictions. Unemployment, according to CMIE, rose to an alarming level of 14.5 percent by mid-May.

From the market perspective, this data is history. The forward-looking market is focusing on the unfolding scenario and its implications for corporate earnings.

Market valuations are high

India is the best performing large market since the crash of late March 2020. This outperformance, when we are in a severe economic crisis and many developed and emerging economies are doing well, should not be ignored.

There is a serious concern that valuations are high. The three important valuation parameters—PE ratio, price to book and market cap to GDP—indicate high valuations. It is, however, important to appreciate that growth and earnings rebound is imminent.

Q4 FY21 numbers indicate growth recovery

The Q4 FY21 GDP numbers offer some clues to the emerging scenario. The Q4 GDP growth print at 1.6 percent, indicating recovery, is clearly positive.

More importantly, the growth rates in manufacturing (6.9 percent) and construction (14.5 percent) are impressive. Finance and real estate also are doing well.

There is reason to believe that the historically low interest rates have become a major tailwind for construction.

Agriculture is another bright spot with a growth rate of 3.6 percent in FY21. The rise in agricultural prices has shifted the terms of trade in favour of agriculture/rural, thereby improving the prospects for aggregate demand but the second wave and the consequent lockdowns have hit the recovery. This has led to downward revisions in FY22 GDP growth rate to around 9 percent from the pre-second wave forecast of around 11 percent.

Dip in growth likely to be confined to Q1 FY22

But, the dip in growth is likely to be confined to the first quarter. The sharp drop in COVID cases augurs well for a smart pick up in growth in the second, third and fourth quarters of FY 22, enabling around 9 percent GDP growth.

This trend projection is on the assumption that fresh COVID cases will fall to around 50,000 by the end of June and a third wave, if at all, will be weak since vaccination would be scaled up over the next few months.

Areas of concern

There are lingering doubts about the sustainability of the recovery since millions have lost their jobs and lakhs of MSMEs have been hugely impacted.

It is possible that after the initial buoyancy from pent-up demand, aggregate demand may again falter due to low purchasing power emanating from loss of jobs and incomes. Another worry is that the MPC has no room to cut rates further since inflationary pressures (WPI inflation in April is 10.49 percent) are rising.

A sharp rebound in corporate profits

The fourth-quarter results surprised with around 100 percent YoY spurt in the profits of the Top 200 companies. The lower corporate tax, lower interest rates and cost-cutting contributed to the surge in profits. Indications are that we are at the beginning of an expansionary phase in corporate profits.

It makes sense to remain invested in this bull market. At elevated valuations, corrections can happen any time.

The known trigger for a correction is the return of inflation in the US and the consequent rise in bond yields. It is also possible that factors that are unknown at present trigger corrections. Investors should always bear this in mind and opt for an investment strategy that minimises the impact of a sharp correction.

There is relative safety in sectors like IT, pharma/healthcare, chemicals and metals, which have high earnings visibility. Top-quality financials also offer long-term safety.

Article first published in Moneycontrol.

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