Market may still have upside compared to bonds if earnings yield remain higher than 3% with growth outlook improving, says Deepak Jasani of HDFC Securities

Market Outlook

Deepak Jasani, Head of Retail Research, HDFC Securities, feels rising bond yields could be the latest party pooper for the Indian market.

In an interview to Moneycontrol’s Sunil Shankar Matkar, he said faster-than-expected increase in inflation can make global central banks reduce the quantitative easing. Apart from this, in India, we have the added uncertainty of the monsoon and the upcoming assembly elections. All these are the risks for market, going ahead.

Edited excerpt:

Q: The market continued to trade in a range for last one month, especially after hitting a record high. Do you think the steep correction of 10-15 percent is warranted at this point of time and why?

Markets remain worried on several fronts. The latest macro data (CPI, IIP etc) does not suggest that our economy is on a smooth and sustainable recovery path. Bond yields abroad have started to rise and market participants now are not sure how much they can rely on assurances of continued low interest rates by US Federal Reserve and other Central Bankers.

Rising interest rates result in valuations of stocks (especially growth stocks including technology) to shrink. Specter of rising inflation across the globe is also bothering traders and investors. Whether the latest stimulus by the US government will provide a sustainable push to its economy beyond a quarter is also not clear.

Locally, we also have the minor concerns whether COVID-19 spread will come under control soon and the uncertainties arising out of state elections due in April. As the markets had run up relentlessly from early November, the correction also has been swift and sharp.

Q: Do you think US bond yields will dent the sentiment in coming months? What could be the impact on India?

As far as stock markets are concerned, rising bond yields could be the latest party pooper. Markets recently underwent a sell-off due to a spike in the already up-trending US bond yields (spiked over 50 bps since January-end), which is resulting in a bond rout in developed markets.

US yields had started their uptrend since August 2020 from 0.5 percent range and touched 1.74 percent. Even Indian 10-year bond yields rose to 6.24 percent, a thirteen month high.

Key premise on which bond yields are rising or rather normalising to pre-COVID levels is that US economic recovery (boosted by various stimulus measures) will be faster than earlier envisaged resulting in rising inflation. Equities as an asset class perform better in an environment of ‘rising growth’ and ‘moderate inflation’. However, the environment to be worried about is rising yields and slowing growth or stagflation, which is the worst environment for stocks.

Historically, low Treasury rates have been seen justifying lofty valuations for equities, as investors have little choice but to look to stocks for returns. While Treasury yields remain low, the move higher could threaten equities with the most stretched valuations. A weaker dollar is generally seen as favourable for stocks by helping to keep global financial conditions loose. In reality the worst case scenario for equity investors would be a selloff in Treasuries accompanied by widening credit spreads and a strong dollar.

In India, equity market may still have upside compared to bonds if earnings yield remains higher than 3 percent with earnings growth outlook improving. Nifty50 is trading at earnings yield of 4.8 percent and 5.8 percent for FY22 and FY23 earnings basis, respectively, versus the bond yield of 6.2 percent.

Key risks to the above assumptions is that global liquidity contracts due to reversal of quantitative easing (QE) by central banks; faster-than-expected increase in inflation break out above the pre-COVID levels. This apart, in India we have the added uncertainty of the coming monsoon and the progress of the precarious fiscal situation.

Interest-rate trends are an unreliable guide to when bull markets will come to an end. Some analysts over the years have believed that it is the interest rate to which stock market investors should pay closest attention. The signal by the Central Banks and rate hikes could definitely lead to a correction in equities. This remains the key to the direction of the stock market in H1FY22, though most Central Banks have so far assured continued easy monetary policy.

Q: What are your broad expectations from March quarter earnings?

On the one hand, we have encouraging data as far as GST collections and direct tax collections. On the other hand, the IIP and core infra numbers do not inspire too much confidence for the March quarter numbers.

However, we would have a favourable base for the March quarter. The financial performance of the Indian corporate sector in Q4FY20 was primarily hurt by consumer and commodity-linked sectors, both of which were impacted significantly as the pandemic started spreading rapidly.

Tepid realisations driven by softening commodity prices, coupled with subdued volumes in light of the pandemic outbreak and macroeconomic slowdown, resulted in revenue contraction for major commodity sectors, including oil and gas, metals & mining and iron & steel. Sales for Nifty50 constituents fell 5.1 percent on-year basis in Q4FY20. Profit after tax (PAT) nose-dived 20 percent to register a fall for the first time since the June quarter of the financial year 2018. Having a low base will help corporate earnings to grow well in Q4FY21.

In March 2021 quarter, commodity prices have risen quite sharply and hence the revenue growth numbers could come in at a healthy pace. However, the same phenomenon could hurt margins of users of these commodities. Commodity cost pressures could start showing up in earnings for Indian companies in the March quarter and beyond. After upgrades in earnings seen over the past two quarters, analysts may wait for June quarter earnings before upgrading earnings once again.

Management commentaries may give an indication about the earnings trajectory in FY22 but given the uncertain situation on Covid-19 and interest rate/inflation front, some of them may try and forecast the earnings trajectory for H1FY22 only.

Q: What are the sectors that can be in a limelight for FY22 especially after seeing at least 60 percent rally in every sector (barring FMCG)? What is your pecking order?

Metals may have some more upside (though after some cooling off). PSU as a theme will perform based on the progress on divestment/privatization. Banks, Auto, Realty, Healthcare indices may find it difficult to rise materially from here on.

Q: FMCG was the clear underperformer in FY21. Do you think it is the right time to pick FMCG stocks? What is your outlook for the sector?

FMCG index has failed to cross the highs of September 2018 so far in this rally. This has got more to do with the fact that these stocks were anyway valued highly and once the focus shifted to cyclicals, (which are cheaper) fresh buying interest in FMCG stocks was limited. These stocks could also suffer due to commodity price inflation.

While there is a scope for the index to play catch-up, ITC and HUL have large weight in the Index and any positive or negative development in either of these stocks could have a large impact on the index. Given the fact that rural populace will have higher spending power due to a good rabi crop/high crop prices and the government spend in rural areas and the fact that the urban population will also restart spending at the old pace after cutting back a little in pandemic times, means that the topline growth of the FMCG companies could be healthy, but margins will have to be tracked closely.

Q: Which factors will be driving the market in FY22?

Indian markets look forward to stability in interest rates – locally and globally – inflation level, low levels of COVID-19 cases and strong economic growth.

Another factor, monsoon, should not disappoint this time and the fiscal situation should remain in control. If these parameters remain on track, we may see continued inflows in the market from global and local investors and valuations of Indian market expanding.

Listing of new-age businesses and divestment of large PSUs can create another bout of excitement for investors.

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