Bulls to Rule for Now
Tripti Kedia January 6, 2021
A year that started with dashed hopes is ending with building expectations. The year 2020 was spoiled by the worst pandemic in a century and huge economic losses. Revival of equity markets in the second half was a pleasant surprise.
The year 2021 looks promising. The bulls are raring to go, reflecting expectations about Covid-19 vaccine launch, promising corporate earnings, accommodative monetary policy, flush of liquidity and 15 per cent Nifty returns seen in CY20. Investors are all strapped and set to ride the bulls, although with some caution. "2021 will be a year of recovery. We have already ridden the roller coaster. With government increasing spending and earnings of companies improving, we have added new clients. It's time to get returns in the first half of this year than the second half," says Rusmik Oza, Executive Vice President, Kotak Securities. During April-September, India added 63 lakh demat accounts as compared to 27.4 lakh in corresponding period last year, an increase of 130 per cent.
The FII Angle
Foreign investors have also pumped in huge liquidity into markets. Data shows that foreign institutional investors (FIIs) pumped in close to $23 billion in India in 2020. Analysts expect that $15-20 billion more will flow in 2021, making India a relative outperformer in comparison to other key emerging markets. South Korea and Taiwan, which posted stellar returns of 26 per cent and 18 per cent, respectively, saw equity outflows of $15-17 billion in March-November 2020. A more predictable and stable policy making under the Biden presidency in the US and weaker dollar due to higher fiscal spending and lower interest rates also augur well for FII inflows to emerging markets.
"Despite our GDP being severely hit in the first half of this fiscal year, we are expecting the low base to take GDP growth to 9 per cent, which will be the main driver for money coming to India," says Oza.
The Valuation Game
Present valuations are at their historical peak due to the liquidity rush. For example, Nifty's 10-year average P/E is 22.73 but it traded at an average of 37.08 in December. This shows the market is pricing in a strong earnings recovery in the coming quarters. This is also risky as a disappointment on this front may mean a sharp correction. Though, for now, nobody is complaining. "Liquidity is likely to be supportive in the near term, driven by expansion in global central bank balance sheets, but it is likely to peak by March'21," says a recent Nomura report.
Naveen Kulkarni, Chief Investment Officer, Axis Securities, says, "With a one-year view, in a market structure that looks bullish, our Nifty December target is 15,300. For FY22, a 30 per cent rise in Nifty EPS (earnings per share) is expected." He thinks mid-caps and small-caps have underperformed for a good part of the year, barring the last quarter. "They should give a return of 10-15 per cent in a year's time." A recent HDFC Securities' report concurs with this as growth-hungry mid-caps flourish in low interest rate regimes. The repo rate has been 4 per cent since May 2020.
There is another reason for the bullish view. The pandemic has forced companies to think differently and quickly by reducing costs/debt, cleaning up balance sheets and redrawing business models from scratch.
However, analysts sounds a note of caution saying multiples of mid-cap stocks are way higher than that of large-caps. "Valuations here make us uncomfortable. We are optimistic about FII flows as they prefer large-caps. We will allocate no more than 10 per cent of our investors portfolio into this segment." The small-caps, he explains, is a large basket and should give a return of 20-30 per cent next year. "Investors could look at allocating about 20 per cent of their portfolio into this segment. Large-caps would be more resilient to a future correction and, hence, a safer bet," says Oza.
Covid-19 pushed the narrative in favour of defensive plays such as information technology (IT) and pharma. IT gained as companies transformed their operations to enable remote working for employees. Pharma, on the other hand, benefited from higher demand due to the pandemic. However, year to date, NBFCs are down 5 per cent, banks 1 per cent and industrials and metals 3 per cent.
A recent Kotak Securities report explains why the recovery theme may work in the new calendar year. "In cyclicals, the focus is on select large banks, capital goods, oil and gas, cement and metals. This should be done with an accumulation strategy as most of these economy-driven sectors are prone to market corrections. Within defensives, FMCG companies could also deliver better returns due to the sector's under-performance in 2020." Besides, consumption has made a strong comeback due to healthy demand in rural areas where above normal monsoon and higher crop sowing have helped farmers retain their income levels.
But a Nomura report says investors should watch out for consumption slowdown and weak demand in urban areas due to the government's limited focus and shut offices, schools and colleges. "Consumption growth had been slowing down even before the pandemic struck in late March 2020. The propensity to spend has been declining as witnessed in higher household savings in FY20. The consumption expenditure may be further impacted due to loss of household incomes. The formal sector with salaried class is relatively less impacted. However, wage growth in the formal sector has been low."
All hopes are pinned on the vaccine. Most stock markets around the world have priced it in on the assumption that it will take away the fear of the virus and trigger economic recovery. But a JP Morgan December report points out that a vaccine may not be a 'silver bullet' in 2021. "We are focusing on investments that can work with or without an effective vaccine. These include companies linked to digital transformation, healthcare innovation and household consumption," it says.
One sector that remained tepid in 2020 but looks like it's ready to soar is real estate. If high debt, inventory pile-up and economic slowdown weighed on realty stocks in 2020, reduced home loan interest rates (sub-7 per cent), lower stamp duty in several states, extension of credit guarantee schemes, among others, are promising to give it new wings. Housing sales in October-December rose to 50,900 units across seven big cities from 29,520 units in the previous quarter. "If real estate were to grow, it would give a boost to the entire economy. We can get into a two-three year cycle where it can give 15-20 per cent returns from the current low base. With interest rates being low, people have more reason to buy a home than not to buy one. Registrations too are looking strong at present," says Kulkarni of Axis Securities.
Covid-19 has also compelled home buyers to recalibrate their priorities in line with the new work from home normal and opt for integrated living in spacious homes. The trend of reverse migration and working from home is being reflected in real estate demand in Tier-II and Tier-III cities as compared to metros.
Banks and NBFCs are also likely to get an impetus with the government injecting huge liquidity into the system. The only issue will be the NPA cycle. Kulkarni says BFSI is set to become the sector of choice for investors due to improvement on the liabilities side. "The plus points are surging treasury income and robust collections. The sector found the going difficult till October but has outperformed the broader market since then."
The point is elaborated in Axis Securities' multi-asset strategy December report. "The market cap of the BFSI space is still 4-5 per cent below pre-Covid levels. With improved outlook and focus on growth, the risk-reward ratio is in favour of this sector. BFSI outperformance will continue in coming quarters also."
Kotak's Oza is confident about select private banks giving handsome returns of 15-20 per cent in 2021.
IT - Big to Become Bigger
Just as the BFSI sector is expected to have a good run as a result of smart money management, the IT sector will gain from structural changes it has had to make in order to become ready for a new world order. For instance, it will be a big beneficiary of companies' shift to digital. The market will also keep an eye on increased outsourcing and big deals - for example the recent multi-billion dollar deal between Infosys and Daimler.
The BSE IT index has risen a whopping 45.6 per cent in 2020, making it the second best performer after the healthcare index. "With transformational complex deals, the pipeline looks good with strong earnings visibility for the next decade. While the dollar aspect will play out from time to time, IT, on its own, will continue to be a winner," says Kulkarni.
Another trend could be big players becoming even bigger as digital revolution forces companies across verticals to migrate to cloud. Kotak's Oza is quick to add here that valuations in IT are still reasonable with 22-30 per cent return on equity. However, he is a little guarded when it comes to pharma and places return on equity at 13-15 per cent. "Price control could upset returns," he says.
Note Of Caution
While the bulls have taken over stock markets, investors must not throw caution to the wind. "Growth revival has not been robust enough. With real GDP CAGR of 2.3 per cent over CY19-22F, the gap with global growth will be at a multi-year low. The Street seems to be ignoring the potential impact of GDP contraction in 1HFY21 on future demand. We think the government bore just 30 per cent of the impact, and most of the rest has been borne by households and small businesses," says a Nomura report.
Retail or corporate credit growth has also not been very robust until now. Even lenders are cautious. Whatever revival high-frequency data indicates is driven by pent-up demand and inventory stocks that are likely to taper off over the next couple of quarters. Sentiments are improving, but one must tread carefully. Experts say the bigger worry is going to be withdrawal of excess liquidity from the banking system.
Besides, with vaccine in sight and economies returning to normalcy in the second half of the calendar year, central banks the world over are likely to revise their stance. "If inflation and interest rates shoot up, bond yields will rise. The equities party will be over," says a concerned Oza. This reverse global liquidity issue should not be ignored, he adds.
Also, cost rationalisation by corporates has cushioned the hit on earnings growth. But one needs to gear up for higher raw material costs due to rise in prices of commodities such as crude oil and steel. Price escalations could, therefore, impact earnings and lead to de-rating of valuations. Government spending has also been hit due to high fiscal deficit while private sector capacities are under-utilised.
Taking note of the macro numbers and opting for well governed companies can help investors embrace change and ride the momentum.
(Tripti Kedia is a Mumbai-based writer)