Just when everything appeared to be settling nicely, the volatility in Indian equity markets has increased materially. The sharp corrections at any hint of adverse event highlights the jitteriness (and to some extent lack of conviction) of market participants. Considering that household investors (and traders) have increased their participation in the market significantly in past 6-8 weeks, the pain quotient of any sharp correction from here could be significantly higher.
Evidently, while the benchmark indices are now mostly flat for
past 8-9 weeks, the sectoral shifts have been meaningful. Investors have
adopted inflation (commodities) and cyclical recovery (mid and small cap) as a
primary investment theme. Financials, discretionary consumption and realty sectors
have witnessed a major “move out”.
The investors positioning seems to be, inter alia, based upon
the following premise:
(a) The earnings
recovery witnessed in 4QFY21 shall continue for most of the FY22 and FY23.
(b) The inflation
which has been mostly a “supply shock” phenomenon in past three quarters will
become a “demand shock” as cyclical recovery continues to gather pace and
supply response lags the demand surge.
(c) End of
forbearance period for loans may lead to accelerated delinquencies, especially
from MSME sector.
(d) RBI shall
continue to pursue accommodative monetary policy, regardless of the fiscal
conditions, inflationary pressures and pace of cyclical recovery.
(e) The companies
may further improve on the multiyear high margins achieved in 2HFY21 and
justify PE rerating of mid and small cap stocks.
The investors’ positioning is mostly based on promise of higher
fiscal spending and incentives for setting up new manufacturing capacities.
Obviously the assumptions suffer from a certain degree of dissonance.
Stress in MSME sector that is driving financials down is not
reflected in sharp outperformance of mid and small cap stocks. Fears of
lockdown, poor income growth etc. are reflecting in underperformance of
discretionary spending (auto, media, realty etc.) but the “demand shock”
expectations in metals etc. contradict this positioning. Service sector
underperformance also mostly belies the cyclical recovery thesis.
The participants’ positioning also does not fully factors, in my
view, the recently added high risk dimension to the RBI’s monetary policy. So
far the quantitative easing (money printing) has been the domain of the
jurisdiction having a universally acceptable currencies (US, EU, Japan, UK).
RBI has ventured into this with a partially convertible currency. This could be
a two edged sword. Could make INR highly volatile and impact the CAD.
The following excerpts from some recent global research are
worth noting:
“US producer price inflation has jumped to a 10-year high.
Business surveys suggest pipeline price pressures continue to build with some
surveys suggesting a greater ability to pass higher costs onto consumers. This
will add to the upside risks for CPI in coming months and increasingly points
to earlier Federal Reserve policy action.” (ING Bank NV)
“China’s renewed focus on de-carbonisation leading to steel
capacity cuts, strong domestic demand and muted global coking coal costs are
likely to sustain high steel margins globally over FY22-23E. Lower Chinese
export rebate as suggested (for months now) in media articles can discourage
Chinese steel exports further. India domestic HRC price ex- Mumbai stands at c.
INR 60k/t , significantly higher than JM/street assumption of INR 48k/t, while
the landed China price at c. INR 68.7k/t leaves significant room for further
price hikes in the domestic steel circuit.” (JM Financial Research)
“After two consecutive quarters of solid earnings beats and
upgrades, we expect another strong quarter, aided by a deflated base of 4QFY20
and healthy demand recovery for the large part of 4QFY21 – as attested by
high-frequency indicators. Performance is expected to be healthy despite
headwinds of commodity cost inflation in various sectors. The key drivers of
the 4QFY21 performance include: a) Metals – on the back of a strong pricing
environment and higher volumes; b) Private Banks and NBFCs – on moderation in
slippages and improved disbursements / collection efficiency; c) a continued
strong performance from IT – as deal wins translate into higher revenues; d)
Autos – as operating leverage benefits offset commodity cost pressures; and e)
Consumer Staples and Durables – on strong demand recovery despite commodity
price inflation. MOFSL and the Nifty are expected to post a healthy two-year
profit CAGR of 16% and 14%, respectively, over 4QFY19–4QFY21” (Motilal Oswal
Securities)
“If our growth projections were to come to fruition, India’s
economy would pass the US$6.4 trillion mark by 2030, with per capita income at
US$4,279 – reaching the upper middle income country threshold. This implies a
real GDP growth of 6% and nominal growth of 10-10.5%. A key ingredient to our
forecast is our estimate that manufacturing as a share of GDP will rise from
approximately 15% of GDP currently to 20% by F2030, implying that its goes from
US$400bn to US$1175bn. We believe that the thrust toward a manufacturing-led
growth will set in motion the virtuous cycle of productive growth of higher
investment - job creation - income growth – higher saving - higher investment
and India would be one of the few large economies offering high nominal
productive growth.” (Morgan Stanley)
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