Prepare for an excessively volatile FY 22

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FY 21 proved to be a painful year for the Indian economy, but a spectacular year for the stock market. While India’s GDP is estimated to have contracted by 8 percent during FY21, the Nifty returned 71 percent, the best in the last 11 years. Mid and small-caps outperformed with gains of 103 percent and 126 percent respectively. It is important to appreciate the fact that these gains look spectacular only because we are comparing FY 21 to FY 20, which saw a massive crash of above 30 percent in March 2020 alone. Those investors who panicked and left the market during the crash lost heavily; those who remained invested made excellent gains; those who bought during the crash and continued investing during the rally made spectacular gains. FY 21 stock market experience reinforced the dictum “Buy the fear”.

Now, the relevant question is: How is FY 22 likely to pan out?

Stock market prediction is challenging even in normal times; in abnormal times like these, prediction becomes extremely difficult. But based on the major macro trends some likely outcomes can be discerned.

India is likely to be the fastest growing large economy in the world in FY22 clocking a GDP growth rate of around 11.5 percent. Sharp recovery in demand and tailwinds from factors like low interest rates is likely to push up corporate earnings sharply. Nifty earning has the potential to grow by above 30 percent pushing Nifty EPS to around 710. If this expected rebound in growth and earnings materialize, market will remain buoyant and may deliver normal returns. However, if negatives, like the second wave of the pandemic, lead to restriction of economic activity, expectations regarding growth and earnings recovery may not materialize. In such a scenario, market returns in FY 22 will be poor.

A major concern for equity markets, globally, is a potential spike in US bond yields. A hugely significant global index is the US 10-year bond yield, which has the potential to impact global stock, bond and currency markets. The US 10-year yield has spurted in recent times, from 0.5 percent in August 2020 to around 1.74 percent by late March 2021.  If the yield moves above 2 percent, there can be a sell-off in global equity markets. India too will be impacted. But exporters like IT will be least impacted since IT will gain from INR depreciation caused by capital outflows. So, portfolio rebalancing in favour of IT can be a good strategy in such an eventuality.

The biggest supportive factor for global stock markets is the Fed’s ultra loose monetary policy and declared position to keep rates at 0 to 0.25 levels through 2023. Investors should look for signs of deviations from this declared stance.

Even if negative triggers don’t happen, markets are unlikely to spurt in FY 22. The simple logic behind this argument is that valuations are high (FY 22 estimated PE is presently above 20) and further appreciation will push markets into bubble territory.

Investors should brace for excessive volatility in FY 22. Expect modest returns of, say, 12 to 15 percent. Tweak portfolios to gain or minimize losses from volatility. Private sector financials, IT, pharma, chemicals, metals, cement and select FMCG segments have the potential to outperform in FY22.

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