A story of revival amid Covid-19: People stayed home but bulls ran wild

Valuations are expensive, but further rally is possible if the Covid situation eases

It was a year characterised by wild swings. While slowing economic growth was a worry, the onset of the Covid-19 pandemic caused a crack that led India's leading indices to lose more than a third of their value in less than five weeks. The indices staged a sharp recovery after May, and are set to end 2020 with gains of more than 80 per cent over March 23 lows, largely driven by easy liquidity sloshing across the globe and the resulting deluge of overseas inflows.

Foreign portfolio investors (FPIs) offloaded stocks worth over Rs 62,000 crore in March and April. Since then, they have been net buyers of stocks in seven of the eight months, with net purchases worth Rs 2.16 trillion, including record Rs 70,896 crore in November.

But, flows from domestic institutional investors (DIIs) reversed sharply in the second half of CY20 as they pulled out money from equity schemes and valuations became unattractive. In CY20, DIIs sold shares worth Rs 28,000 crore, against FPIs’ net purchases of Rs 1.66 trillion.

The year also saw the emergence of the ‘Robinhood’ phenomenon, with retail investors opting for direct stock purchases during periods of a sharp correction. “Retail investors bought on dips, even during periods of steep correction. These investors are now willing to create their own portfolios, instead of giving money to mutual funds,” says B Gopkumar, CEO, Axis Securities.

According to Vinit Sambre, head of equities at DSP Mutual Fund, the sheer magnitude of the market moves in a short span caught everyone by surprise. “Contradictory data points on likely economic impact of the pandemic, and news flows on timelines of vaccine and spread of virus only raised uncertainties.”

“The response of the market to the pandemic was somewhat surprising. There were expectations that things would go from bad to worse. Instead, the mood turned around rather quickly,” says UR Bhat, director, Dalton Capital Advisors (India). The pendulum swung to the other extreme, he says, with the markets at record highs and valuations getting stretched, driven by a record quantitative easing programme of global central banks and prospects of a Covid shot.

Indian equities are no longer cheap vis-a-vis global markets, and only a short distance away from being the most expensive they have ever been. The Nifty is trading at 21.3x on 12-month forward price-to-earnings (PE) multiples, 2.6 standard deviation above its long-term average.

“Mid- and small-caps are trading above their long-term average and we advise investors to avoid investing in these stocks from a one-year time frame,” says Sambre. He is positive on information technology (to benefit from technology adoption), health care (rising health care needs and improved US outlook for specialty generics), and consumer discretionary (economy opening up and rising consumer spending). He is hopeful sectors, such as automobile, cement and engineering, will benefit from the cyclical recovery.

Also, the government and the RBI have announced several measures to lift the economy and support businesses and individuals. Also, corporate earnings for the September quarter surprised positively with strong margin gains. But, more is needed and there’s a reason to be cautious. “The upside must come from earnings... A year from now the market would be looking at CY22/FY23 earnings, and even if the Nifty and FY22 and FY23 EPS forecasts do not change, the P/E would have still not reverted to pre-Covid levels,” said analysts led by Neelkanth Mishra in Credit Suisse’s recent India market strategy report.

At 20x FY23 earnings, Axis Securities has set a December 2021 target of 14,600 for the Nifty50. Morgan Stanley equity strategist Ridham Desai has forecast a base case probability of 50,000 for the Sensex for December 2021 and a bull case target (30 per cent probability) of 59,000, if the virus situation improves, the recovery in growth is sustained and global stimulus supports asset prices. The bear case target (20 per cent probability) is 37,000, if the virus issue lingers in 2021 and growth falters.

“As of now, the market is factoring a base case scenario with a V-shaped recovery for the economy and sharp pick-up in earnings growth. But a number of uncertainties remain,” says Dalton’s Bhat. A tense US-China relationship and geopolitical tensions in Iran and Syria are some risks. “A lot, however, will hinge on how the pandemic scenario plays out and the liquidity stance taken by central banks. Valuations are stretched and any negative news flows on these fronts can trigger a correction,” Bhat adds.