By Unmesh Sharma
An oft-asked question these days by investors and market 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 sound counter intuitive but the very fact that concerns around the virus have not receded is a support to the market. Globally Central Banks are in no position to withdraw liquidity support. In the trade-off between inflation and growth, monetary and fiscal policy is likely to err on the side of growth in the current environment.
Indeed, inflation fears have emerged in the last few months, causing some volatility in markets especially the commodity-consuming Emerging Markets such as India. Trying to predict short term trends in markets is a mug’s game given the complex inter-play of these factors. At HDFC Securities, we see no merit in trying to predict ultra-short term trends by second-guessing the Fed and look beyond.
It is our conviction that the macro trend especially on global liquidity is supportive from a 12-15 months scenario. We believe we are in an era of multi-year (if not multi-decadal) global deflationary trends, driven by technology amongst other factors. Inflationary concerns are therefore likely to be transitory. There will be pockets where inflation will hurt will but in most cases, a prompt and adequate supply response will allay concerns. This also explains the subdued reaction of bond yields in the recent past. We therefore do not see a re-emergence of the widespread panic we last saw in 2020 when Covid-19 first emerged.
This is not to say there are no imponderables. For most investors in India, belonging to the upper economic echelons in tier-1 cities, the second wave has hit very close to home. In addition, the second wave has been more severe in the rural areas. The rural economy has seen an impact on remittances due to reverse migration and the health crisis. Market participants would need to keep a closer eye on the monsoon to pre-empt any emergence of economic distress in rural India. Will demand suffer from PTSD? It may take months or even years before things get back to normal and it is tough to firm up a view at this time.
Notwithstanding this, what we do know is that the impact of the phased and calibrated lockdown in the second wave has not impacted the economy as much as the first wave in 2020. Lessons learnt from the second wave will (hopefully) accelerate the vaccination drive and prevent a severe 3rd wave.
Indeed, we think the markets will outperform the economy. As we are mid-way through the earnings season, our research team has analysed the emerging earnings picture. ~70% of our coverage stocks have beaten estimates in the fourth quarter (January to March 2021). We acknowledge that this is backward looking. However, despite the muted outlook due to the second wave, NIFTY earnings’ estimates for FY22 / FY23 are largely unchanged. This is because the sectors impacted by the second wave have a low weight in aggregate earnings. Among the large contributors, our team points out that banks (especially the large banks with strong deposit franchises) have navigated the crisis well so far- we remain sanguine about the NPA and provision scenario.
We believe this will remain a stock pickers’ market in FY22 and prefer economy-facing sectors and mid / small caps (in sectors where ‘winner-does-not-take-all’) as markets start looking at FY23 and beyond. Our preferred sectors are large banks, cement, consumer durables, infrastructure, gas, insurance and capital markets. We remain underweight on consumption (staples, discretionary and autos), NBFCs and oil. We remain bullish on IT, Pharma and Chemicals but have become selective given the stellar run-up and stretched valuations.
(Unmesh Sharma is Head of Institutional Equities at HDFC Securities Ltd. Views expressed are the author’s own.)