Positive and negative market signals

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By mid-February, Nifty crossed 15200 level giving an incredible 100 percent returns from the 2020 March lows. This kind of quick and sharp turnaround is very rare. Investors who remained invested and those who continued to invest systematically have made   excellent returns. The MSCI World Index is up by more than 70 percent from the 2020 March lows indicating the global nature of this bull run.

From the investors’ perspective, the important questions are:

How long will this rally continue?

Are the valuations justified?

What are the threats to the bull market?

What should be the right investment strategy?

It is impossible to predict how long the rally will        continue. As always, there are bullish and bearish views. Presently, bulls are in the majority. Most market experts believe that markets will remain bullish for an extended period of time. Low interest rates, ample   liquidity and hyperactive retail participation can support the bull market. For India, particularly, the prospects are improving impressively. The economy is rebounding sharply and corporate results are much better than  expected. GDP growth in FY 22 is likely to be around 11 percent assisted by the low base. Corporate earnings growth can be anywhere between 30 to 35 percent. This can deliver a Nifty EPS of around 720 for FY22, bringing the valuations down to more reasonable levels. But even then, at Nifty 15000, the one-year   forward PE will be around 21, which is 40 percent   higher than historical valuations. The MSCI India Index, too, is at 40 percent premium to emerging markets. But, if we can sustain the GDP and corporate earnings growth beyond FY 22, valuations can normalize. A lot depends on how growth and corporate earnings pan out, going forward.

Investors should be aware of the threats to the bull  market. Since this is a global rally, the threat to the  market also can be global. A major emerging concern is the rise in US bond yields which rose to 1.36 percent by February 20th. Markets fear a spike in inflation in the coming months. The ultra-easy monetary policy being implemented by the leading central banks has not been inflationary since 2009. But now, the Biden administration is keen on implementing a massive 1.9 trillion dollar fiscal stimulus too.  Markets fear that this massive monetary cum fiscal stimulus can trigger inflation, and this fear is reflected in the rising bond yield. If the US 10-year yield continues to rise, it can spill over to other developed market bond yields too. Rising yield and higher cost of money can negatively impact stock markets, especially when valuations are high. Investors have to be mindful about this. 

In brief, there are both positive and negative market signals. While GDP growth and corporate earnings growth signals are positive, US bond yield trends are negative. Market direction will depend on which of these two conflicting trends will gather traction, going forward. It makes sense to remain invested in quality stocks, particularly in performing sectors. Since the economy is in a sharp rebound, segments that gain from this, like financials, infra, autos and industrials are likely to outperform this year. Mid and small-cap segment also is likely to outperform.

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