The year has turned around. After a sharp correction in the first half of the Calendar 2020, markets turned buoyant in the second half. At this juncture, let us try and build a thesis for the market for the New Year.
Let us consider the following points:
- There has been a gap of one year between the last high and the current high of the market. In the interim period, the market fell in line with GDP and profits have now come back. Profits were higher by over 20 per cent in Q2 on a like-to-like basis. Markets are now 20% higher over same period last year, and hence, it seems to be lagging the profit recovery. This was on account of the fact that Q2 profits were driven by cost cuts and may not be sustainable. For the year as a whole, after Q2 earnings, profit for the index is expected to be 10% higher than last year’s.
- In the Q3 earnings season, which is just around the corner, we do expect a strong showing again. Some of the cost cuts, such as employee wage cuts, have been largely restored and one expects to see a growth in wage costs. However, travel-related costs, promotions and conferences are still lower. Ad expenses would be high on account of focused marketing during the festive season. However, sales have been strong across the board, except in areas that remain restricted. Hence, costs would be higher in Q3 vs Q2, and hence, margins may be lower. We still expect strong profit growth on a YoY basis. In the IT space, which would be the first one to announce results, YoY growth should be stronger than expected. Accenture has announced its numbers for its quarter ending November 30, and they were significantly stronger than expected. The industrial commodities segment should deliver strong numbers given the strength in commodity prices and conversion margins. In financials, the other large area of market, loan growth has been stronger in retail, and this part could deliver better numbers.
- Discretionary consumer spend has been strong, as have been realty purchases. We do expect that the festival season has been better than expected for Indian companies as a whole, and there is a chance of a further uptick in full-year expectations after Q3.
- Going forward, Q4FY21 and Q1FY22 earnings would have the benefit of a lower base of last period. Hence, for some time, the market would have the support of strong YoY earnings growth. With some of the cost cuts sticking, we do believe the outlook for FY22 profits would be strong.
- The policy environment has been supportive to catalyse an economic recovery. Central, state, local and municipal governments have all been trying to kickstart the economy by incentivising new businesses (PLI schemes), tax cuts (e.g. stamp duty cut in Maharashtra), lowering of prices of resources such as FSI, etc. We expect this to continue in the Budget and do not expect any tax increase on any part of the market or the economy. This is a period when policy makers the world over are supporting the population and businesses. The focus on fiscal is low around the world.
- Liquidity flows have been strong and we are increasing forex at a rapid pace. The economy is also coming back, and GST collections are now at a record. This does provide better fiscal legroom to the policy makers. The environment provides a golden opportunity to present a Budget that could be remembered for a long time.
- FPI flows remained strong throughout December vs earlier years when December would usually see flows taper off. We expect FPI flows to be strong in the New Year, given the improvement in the Indian economy and increased weightage for India in the MSCI index.
- There has been a sharp reduction in interest rates around the world and in India. Stock prices are future cash flows discounted to the present, and a lower discount rate enhances the present value. This is reflecting only partly in the market levels. The key here is the sustainability of the low interest regime. If it sustains, chances are that stock valuations could even improve. We do expect lower interest rates to sustain.
- The Indian retail investor has raised substantial cash through redemptions and selling to FPIs. As this cash is redeployed in the market, the market breadth should remain good and strong. We are already seeing signs of the same and it should persist.
- Nifty EPS has been in the 400s for now seven years. While the economy has been growing in the interim, earnings have not kept pace on account of various factors, including heightened competitive intensity for manufacturing and loan loss provisions for banks. In FY22, they are expected to cross 600 vs the 490 currently expected for FY21. FY23 should also be a good year for earnings growth. Sharp earnings growth should support market levels going forward.
- To sum up, Calendar 2021 does bring with itself a lot of hope and promise. Earnings momentum should remain strong, policy framework should be favourable, liquidity and interest rates should sustain at current levels, and hence, we expect valuations to sustain. We expect the valuations to sustain and believe that there is a good chance of index delivering low-teens returns in the New Year. We do believe the market breadth would be good and for most investors the New Year should feel good.