Dhananjay Sinha, MD & Chief – Strategist at JM Financial Institutional Securities, does not expect the third wave of COVID-19 to have a significant impact on the markets. According to him, quantitative easing in the US poses a bigger threat to the Indian markets, but the impact may not be significant.
In an interview with Moneycontrol’s Sunil Shankar Matkar, Sinha talks about the buoyancy in the primary market, risks for Indian markets, the impact of quantitative easing and much more. Edited Excerpts:
Q: When should investors start worrying about the tapering of bond purchases by the US Federal Reserve?
The relevance of the US Federal Reserve’s quantitative easing (QE) is rooted in the liquidity induced asset price expansion since March 2020. US money supply expanded by $ 5 trillion to $ 20.5 trillion implying a huge jump to 90 percent of GDP from 70 percent. This resulted in a robust jump in portfolio flows into emerging markets, particularly China and India, quickly compressing market risk premium despite the pandemic and lockdown shocks.
India saw a $ 35 billion inflow in portfolios resulting in a stupendous expansion in market multiples and over-time also aided rebound in growth, which was also aided by fiscal stimulus and revival in global trade. Nifty’s 12-month trailing price-earnings multiple rebounded from 17 times in March 2020 to a peak of 40 times in February 2021.
The risk now is that this supply of the liquidity exhilarant may subside with the advent of US tapering. We have seen the US money supply growth decelerating from 24 percent to 12 percent over the past five months, which has also resulted in a stronger US dollar, moderating in portfolio flows into India.
While earnings growth has recovered from the pandemic shock, the 12-month trailing multiple for Nifty50 has declined to 28 times. Hence, the start of QE tapering can potential moderate it further to pre-Covid levels of 24-25 times. This will imply that macro play of liquidity on the markets will give way to more fundamental and cycle rotation driven investments.
The US bond curve has been factoring in tapering with a 10-year yield declining to 1.25 percent from 1.75 percent in March 2021 and 30 years from 2.50 percent to 1.90 percent. Putting all things together, we expect QE tapering to start from November 2021, which will be relevant from FII flows standpoint. We expect the impact of tapering not to be very intense.
Q: With the primary market abuzz, do you expect record fundraising via IPOs in 2021? Also, do you think LIC and NSE will come out with their respective IPOs this year?
The IPO market has been fairly buoyant since 2017 and there is a robust pipeline going forward. The buoyancy in the midcap and smallcap space amid abundant liquidity is a favourable environment for fundraising by corporates, both through debt and equity instruments. And for both private and public sector fundraising. Favourable market condition has helped companies to restructure balance sheets and banks to enhance their capital buffer.
Q: Most public issues have seen an overwhelming response from retail investors, what is the excitement about?
Retail investors have been fairly active in the mid and small-cap space. Unlike the 2017 boom, participation of discretional retail money in the equity market has been much higher; much of the retail money has taken the direct route, unlike 2017 when domestic funds were more active. Apart from retail discretionary money, we are also noticing FIIs have gone beyond largecaps by participating in select mid and small cap names across several sectors.
In my view, the surplus liquidity reflected by RBI’s liquidity adjustment facility (LAF) balance at 3 percent of bank deposits, weak credit demand, improved cash flows in surviving businesses, buy backs by companies that have seen significant expansion in cash flow from operation and outperformance of mid and small-cap stocks are all contributing variously to the IPO buoyancy.
Q: Foreign investors have turned net sellers for some time now but the market has not seen a major correction; why?
FIIs have been on the selling side over the past month or so and net inflows have moderated over the past few months. However, retail participation continues to be strong. There have been a good amount of money that is moving out to IPOs. Hence, we have flattish benchmark indices and outperforming mid & small caps. Within the benchmark, however, there is a good amount of sector rotation taking place with investors preferring sectors and stocks that have strong visibility and shunning sectors that are likely to face moderation; corporate results have been broadly been in line, but there are margin pressure emerging in across several manufacturing sectors. In addition there are concerns on valuations. Hence, institutional participation will likely be measured.
Q: Do you see the third COVID wave as a major threat? What are some other things that investors should watch out for?
There are initial signs of Wave 3 emerging. But the incremental impact is likely to be limited. We have seen markets reaction to new waves diminishing as firms and households have adapted to the pandemic, there are more localized responses, which imply that economic damage from new waves will be lesser. Interestingly we have seen the benchmark rebounding by 70-80 percent as the Wave 1 progressed after the initial 30 percent decline. During Wave 2 the market corrected by just 5-6 percent and then regained once the wave crossed the inflection point in May 2021. So it will be fair to assume that the impact of Wave 3 will be shallow. The primary reason behind this declining response is the overwhelming impact of surplus liquidity, which depresses market risk premium very quickly. Thus we need to focus more on how the liquidity cycle pans out in the context of US tapering, more than the Wave 3 risks.
Q: The market continued its fresh record high journey in the second half of 2021. What are driving factors for the market – is it FOMO, TINA, or plain liquidity?
We believe that incremental gains will moderate after the quick 100 percent rebound from March 2020 lows. As mentioned earlier the contribution of surplus liquidity, both global and domestic has been immense. We expect some of the underlying global factors to undergo inflections, which will imply gradual improvement.
Q: Do you think it is time to be cautious considering the outperformance of midcap and smallcaps over largecaps? What should investors do now?
As we have seen in 2018 which followed the retail led exuberance of 2017, things can quickly transform into volatile times. Last 30 years history shows us that there is circular causality between retail participation and stock price valuations; price rise attracts retail participation, which in turn pushes up prices and the self-fulfilling cycle sets in. It requires global triggers like financial market volatility, tapering, trade disruptions etc or even domestic regulatory measure to break that spiralling circularity. So the simple advice will be study the stocks you are investing in carefully; consider market power and valuation matrix very seriously.
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