Fed taper, higher interest rates to weigh on market returns in Samvat 2078

Macro headwinds, such as high global crude oil prices, supply-chain disruptions escalating tensions between US and China, are likely to keep global and local markets volatile

After a year of eye-popping returns, gains for the benchmark indices in Samvat 2078 may be relatively muted, given the rich valuations and the imminent taper of the US Federal Reserve’s bond-buying programme, which may impact portfolio flows into emerging markets (EMs), such as India.

Macro headwinds, such as high global crude oil prices, supply-chain disruptions, inflationary pressures, the possibility of hardening interest rates across the globe, internal economic challenges in China and its global ramifications, and escalating tensions between the US and China, are likely to keep global and local markets volatile, revealed analysts.

“The markets are currently not fully discounting these headwinds. Having said that, companies whose stock prices are reflecting the optimistic outlook three-four years down the line are most vulnerable to price and time corrections,” said Krishna Kumar Karwa, managing director (MD), Emkay Global Financial Services.

The last few weeks has seen sustained selling by foreign portfolio investors, which does not augur well for Indian equities. “If the US Fed’s tone becomes a bit more hawkish, selling in EMs may accelerate. The positives are all factored in and it will not be easy for these valuations to sustain unless there’s more traction on the earnings front,” said U R Bhat, co-founder and director, Alphaniti Fintech, adding that geopolitical tensions between the US and China over Taiwan and the South China Sea, as well as developments on the Iran nuclear deal, could also impact portfolio flows.

Bhat, however, counts the improvement in the goods and services tax collections, pick-up in exports, and the second quarter results of companies as positives. “Formalisation of the economy has accelerated in the aftermath of the Covid-19 pandemic, which is being reflected in the stock market as well. Government’s finances are also in reasonably good shape, despite the pandemic,” he said.

“The migration of small investors to equities has been a continuing theme. These first-time investors, however, haven’t seen a bear market and it would be interesting to see how they would react if there is a steep fall,” added Bhat.

The Nifty 50 has gained 40 per cent over the past year, while the benchmark small- and mid-cap indices have delivered 70-80 per cent returns, with high beta, cyclicals, and value stocks emerging as key themes during the year.

The pandemic year has translated into superior profitability for Indian corporates, resulting in the Nifty earnings per share growth of 15 per cent in 2020-21, led by cost rationalisation and pent-up demand.

“With the economic cycle picking up, we expect the corporate earnings growth to revive as well. Markets have always moved in tandem with earnings growth. Although there would be ups and downs in between, we expect the overall trend of the market to remain positive in Samvat 2078 as well,” said Motilal Oswal, MD and chief executive officer, Motilal Oswal Financial Services.

Cumulative and rolling net profit of NSE 500 universe for the last four quarters has touched an all-time high, with loss-making sectors turning positive and significantly contributing to net profitability.

“Samvat 2078 will be a year of balance-sheet leverage, led by significant improvement in corporate profitability. The return on equity for the broader market is improving after a muted performance for several years. The Indian market has entered into an earning’s upcycle with an expectation of more than 20 per cent growth in Nifty’s earnings in the next two years. With faster economic recovery on the cards, more cyclical sectors are likely to join the rally with expectation of higher government spending, moving forward,” said a note by Axis Securities.

Interest rates and inflation may see an uptick in the coming year, an environment which may favour banks. Digital and Cloud will continue to remain major long-term structural themes, while travel and tourism may gain momentum.

Robust demand environment, coupled with a weak rupee, augurs well for Indian information technology companies. “The pandemic has only accelerated Cloud and digital implementation across the globe. While higher attrition and cost escalation can be a dampener over next two quarters, currency and demand gives a good cushion. This sector also offers a good hedge against any volatility in the environment,” added a note by Carnelian Asset Management.

Themes for Samvat 2078

• Small- and mid-caps are picking up steam and balance-sheet leveraging is likely to play out in 2022, with improved outlook on return ratios and profitability

• Housing and banking will be major themes to watch out for in 2022 on account of their improved outlook and current lower interest rate regime

• The infrastructure sector may benefit from government spending

• Digital and Cloud will continue to remain major long-term structural themes

• Travel and tourism could gain momentum