We are in a ferocious bull market globally and bull markets are known to climb many walls of worries. This bull run, which began after the crash of March 2020, has already climbed many, including the formidable wall thrown up by the recession of 2020.
At present, two major walls can block this good run and the bulls’ attempt to climb these walls is causing excessive volatility in markets. It is important to understand this market construct.
Bond bears vs equity bulls to continue
The biggest challenge to the global bull market will come from US bond yields, which in turn, will be dictated by inflation in that country.
The US CPI inflation print at 4.26 percent year-on-year in April surprised on the upside, pushing the 10-year yield above 1.69 percent. Markets promptly sold off with the Dow Jones, S&P and Nasdaq Composite correcting sharply by 2 percent, 2.1 percent and 2.7 percent, respectively, on May 12.
The bond bears, strengthened by the conviction that inflation will get entrenched forcing the Fed to taper its QE earlier than expected, went on the rampage and won the day. But the very next day, the equity bulls came charging back and their message that inflation is transitory and the Fed will remain accommodative for long carried the day.
The jury is still out on whether the inflation in the US is transitory or entrenched. This “equity bulls versus bond bears” bout has many more rounds to go. Even though the bond bears are licking their wounds now, they are capable of a major ambush in the not too distant future.
The major domestic challenge to the bull market emanates from the second coronavirus wave and its impact on economic growth and corporate earnings in FY22. It is a fact that the second wave has proven to be far worse than all estimates and is sure to take a toll on growth and corporate earnings. The pre-second wave growth assumption of 11 percent is getting revised downwards and now the consensus estimate is around 9 percent. Corporate earnings, too, will take a hit but is likely to be confined to Q1FY22.
Some silver linings are breaking through the dark ominous second wave clouds. Recent trends are pointing to a steady decline in fresh cases and a sustained rise in recoveries. Daily infections have dipped below 3 lakh. If this trend sustains, the second COVID curve will start declining sharply and the widespread restrictions will likely be lifted by early June. The market is discounting this emerging scenario.
It is important to remain invested in this bull market, particularly in quality stocks in IT, pharma, leading financials (top private sector banks, mortgage lenders, fintech companies, AMCs), metals, industrials, chemicals and cement that have good earnings visibility. If the bull run continues, these segments have more room to go up. However, taking some money off the table is never a bad idea.
Not the time to be aggressively bullish
Since there is a lot of uncertainty and the situation is still evolving, investors have to be cautious. If the situation takes a turn for the worse, there is not much room for further fiscal and monetary stimulus. The fact that valuations are high and at high valuations, markets are vulnerable to corrections should always be in investors’ minds.
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