By Unmesh Sharma
An oft-asked query these days by investors and marketplace participants is “what explains the disconnect between the tragedy playing out in India versus the euphoria in the markets? How does one reconcile the two and more importantly, how does one invest in this scenario?” It may well sound counter intuitive but the extremely truth that issues about the virus have not receded is a help to the marketplace. Globally Central Banks are in no position to withdraw liquidity help. In the trade-off among inflation and development, monetary and fiscal policy is most likely to err on the side of development in the present atmosphere.
Indeed, inflation fears have emerged in the last couple of months, causing some volatility in markets specifically the commodity-consuming Emerging Markets such as India. Trying to predict brief term trends in markets is a mug’s game offered the complicated inter-play of these aspects. At HDFC Securities, we see no merit in attempting to predict ultra-brief term trends by second-guessing the Fed and look beyond.
It is our conviction that the macro trend specifically on worldwide liquidity is supportive from a 12-15 months situation. We think we are in an era of multi-year (if not multi-decadal) worldwide deflationary trends, driven by technologies amongst other aspects. Inflationary issues are thus most likely to be transitory. There will be pockets exactly where inflation will hurt will but in most circumstances, a prompt and sufficient provide response will allay issues. This also explains the subdued reaction of bond yields in the current previous. We thus do not see a re-emergence of the widespread panic we last saw in 2020 when Covid-19 1st emerged.
This is not to say there are no imponderables. For most investors in India, belonging to the upper financial echelons in tier-1 cities, the second wave has hit extremely close to home. In addition, the second wave has been more extreme in the rural regions. The rural economy has seen an effect on remittances due to reverse migration and the overall health crisis. Market participants would require to maintain a closer eye on the monsoon to pre-empt any emergence of financial distress in rural India. Will demand endure from PTSD? It may well take months or even years prior to issues get back to standard and it is hard to firm up a view at this time.
Notwithstanding this, what we do know is that the effect of the phased and calibrated lockdown in the second wave has not impacted the economy as a lot as the 1st wave in 2020. Lessons learnt from the second wave will (hopefully) accelerate the vaccination drive and protect against a extreme 3rd wave.
Indeed, we assume the markets will outperform the economy. As we are mid-way by way of the earnings season, our analysis group has analysed the emerging earnings image. ~70% of our coverage stocks have beaten estimates in the fourth quarter (January to March 2021). We acknowledge that this is backward seeking. However, in spite of the muted outlook due to the second wave, NIFTY earnings’ estimates for FY22 / FY23 are largely unchanged. This is simply because the sectors impacted by the second wave have a low weight in aggregate earnings. Among the significant contributors, our group points out that banks (specifically the significant banks with powerful deposit franchises) have navigated the crisis nicely so far- we stay sanguine about the NPA and provision situation.
We think this will stay a stock pickers’ marketplace in FY22 and choose economy-facing sectors and mid / smaller caps (in sectors exactly where ‘winner-does-not-take-all’) as markets commence seeking at FY23 and beyond. Our preferred sectors are significant banks, cement, customer durables, infrastructure, gas, insurance coverage and capital markets. We stay underweight on consumption (staples, discretionary and autos), NBFCs and oil. We stay bullish on IT, Pharma and Chemicals but have turn out to be selective offered the stellar run-up and stretched valuations.
(Unmesh Sharma is Head of Institutional Equities at HDFC Securities Ltd. Views expressed are the author’s personal.)