Markets downside risk has reduced … however the medium term performance has challenges

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The Indian market was consolidating with a negative bias during June and July in anticipation of a fall in monetary support as the economy recovered well in the quarter ended June, and the need for continuing easy money policy lessens. At the same time, rising economy prices were putting pressure to reverse the policy. Along with that, rising fundamental concerns of high valuations, decade-high inflation, and delta variant was affecting global equity market. For emerging markets, like India, the cautious global trend was leading to FII selling. A marginal uptrend started in August in anticipation that the US Federal Bank would maintain the dovish policy as the overall economy is still under the danger of pandemic, based on recent drop in economic data & delta variant. This improving trend got extended handsomely in September after the in-line outlook by FED. This momentum in India can continue in the short-term, supported by rise in FIIs buying. While on a medium-term basis we can again fall under consolidation since QE is bound to normalize and markets are at peak. The positive is that the likeliness of a sharp fallout in the market has reduced as the dovish statement reveals that a fall in supportive monetary measures will be on a determined and small manner.

The global market has benefited from the dovish outlook

The Fed chair statement, provided in the month end of August, in Jackson Hole, was presumed to set the precedence to future tapering plans. The market knew that QE is going to normalize and wanted to know the rate of tapering. Because, if the rate of rewinding is at rapid rate, the effect on equity market will be elevated, whereas if it is slow the impact will be low.

A dovish commentary by Mr. Powell (FED Chair) stating that the tapering will be on a step-by-step method based on the upcoming economy data has changed the wavering scenario. Along with FED, ECB (Europe Central Bank) also provided a positive outlook in the September policy meet, stating that the ongoing QE policy will continue till March 2022 and reversal of QE will start on a calculated manner, based on the economic outlook.

Some correction has started but the broad market is solid. The positive trend is spreading to Mid and Small caps, which can continue in the short-term.

Future trend will be based on economic data

Henceforth, the global trend of broad equity market will be based on upcoming economic data. If the data is very positive, it can have a negative effect on the global market due to the rise in tapering. Fundamentally, it will be in dichotomy to improving economy and earnings growth. This is highly possible because the main factor for the humongous rally in pandemic is monetary and fiscal support, any change in the measure will affect in maintaining the premium valuation of the equity market.

In November, December and January, the market can get volatile during the announcement of economy and delta variant data and FED policies dates. However, we can presume that the extent of volatility will be low as it is clear that the amount of tapering will be small.

A positive effect on Indian Market

This sentiment has carried thoroughly into the domestic market. It is also supported by domestic positive economic data releases like GDP, GST and PMIs suggesting that many parts of business activities have reverted to pre-Covid levels. And further unlocking of the economy is going to additionally boost the market in the coming quarters. This has lifted buying in mid and small caps by retail and MF investors along with comeback by FIIs inflows after a gap.

On a long-term basis, India is helped by high FDI as the best attractive destination for foreign investors due to healthy economy, politically stable and skilled workforce. As per global survey,  worlds’ many leading businesses are planning to invest either for the first time or on additional expansion plans. As per the survey, India can target attracting greater FDI into seven capital-intensive sectors including textile and apparel, food processing, electronics, pharmaceuticals, vehicles and parts, chemicals, and capital goods.

Mid & Small caps will do better

This change in sentiment has ended the consolidation of mid & small caps. Their broad indices had dipped by 6% and 10% from 52wk high, respectively, clearing opportunities to trade on a short to medium-term basis. The degree of fall is widely scrambled, which makes the call on a stock-to-stock basis.

Now, this positive trend can continue in the short to medium-term. The immediate best bounce back opportunities are on stocks and sectors which are to benefit the most from the unlocking of economy like Capital Goods, Industrials, Metals and Infra. Some of such beneficiaries like Auto and Banking can be expected to join later in the coming months as current fundamental data is weak due to the second wave. New generation companies, global contract manufacturers and sectors like Chemicals, IT and Pharma looks good with high growth and new business model as per the domestic  and global demand. Value buying will also be a key factor in this premium market, for sectors like FMCG, durable  and non-durable consumption ideas and Banking sector, with accumulation as a good strategy on a long-term basis.

On long-term basis focus on large caps

In the near-term, the broad market can trade with a positive bias. However, in between volatility will emerge though economy progresses well. If the fundamental progress is good, the market may not acknowledge it equally. Because the extra liquidity in the market will reduce over a period. This can have a higher effect on the market even if it will be slowly supplemented by rise in real economic growth. As a result, the performance of the market on a medium-term basis will be a challenge.

The long-term market will be supported by the unlocking of world economy and fiscal support. Despite the two headwinds of fall in liquidity and high valuations, we feel that this consolidation will be on a medium-term basis, supported by low interest rate cycle and fiscal policies. The other risk is the rising geo-political risk for which market is not much concerned currently. The joker in the pack for EMs is the collapse of Chinese market.

The rebound of Mid and Small caps may continue in the short-term. However, on a long-term basis the momentum will be more on large caps as they are more attractive based on a risk to reward basis. Large caps are expected to benefit more from unlocking, fair valuation compared to the broad market and momentum to safe assets, amid the rising global volatility.

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