The on-going market rally has been termed as liquidity-driven and it is being said that the high rate of return will not be sustainable. We agree that the rapid rate of performance will fall and there is a high risk of downfall in the short term since a high amount of FII inflows is the main driver of the rally. FII inflows jumped from November and any fall or change in inflows will have a cascading effect on the market since other investors, especially DIIs, are booking profits, which is unlikely to change quickly.
What can change the view of FIIs is a stronger dollar, which is pouring to emerging markets (EMs) due to low yields in the US, weak inflation forecast and easy money policy.
Beyond these risk factors, we should also consider the positive fact that India is getting a higher amount of inflows compared to other EMs because of the inherent value that stems from being seen as one the largest economy in the world in the making.
India has undergone undertaken several reforms from 2017 to 2020 and it has a reformist agenda for the future too, including emerging as a key export hub. Some of the benefits are already visible in areas like pharma, chemicals and IT.
There are other positives too, which will help the market to remain buoyant like the new set of fiscal and monetary packages to be announced in 2021, Union Budget, high double-digit earnings growth and low interest rates. These will have a multiplier effect on stocks and sectors to maintain good valuation in the short to medium-term.
Since the March low, the market has been doing well due to many factors, starting from the quick and friendly policy of central banks, continuous fiscal announcements, reopening of the economy, monthly improvement in high-frequency economic data, fall in financial risk due to easy money policy for industries, US election results, vaccine development, zero-interest-rate policy, high liquidity, continuous accommodative stance and late-effect benefits of reforms undertaken in the last three years. These factors will continue to have a positive effect on the market.
Retail investors, however, should also be aware of market risks, especially in the near term, with main and broader indices up by 90 percent to 120 percent, respectively, from March lows. Low margin of safety due to rich valuation is another risk. Valuation has become just a number, it is not following the fundamentals, there is a disconnect between them.
Expectations are high from the budget but the government's fiscal position is weak, which can impact spending. The biggest expectation is that the government will spend more and relax the fiscal target due to the coronavirus. If so, this will have a crowding out effect on the debt market leading to high interest rates and low private spending. The fiscal deficit for 2021 is expected at 7 percent, double that of the 3.5 percent predicted earlier.
The risk of a second wave attack seems to be underestimated and is likely to lead to a double recession in Europe. It has also raised concerns about the efficacy of vaccination but it seems unwarranted.
Redemption in domestic institutions and a possible increase in global volatility can trigger selling by FIIs and all these factors can have a big impact on the Indian rally in the short term.
Despite the strong rally, there are still many stocks and sectors that have underperformed compared to the broad market during 2020. They will catch up and can do better in 2021. They will be from cyclical and growth themes as the economy flourishes. These sectors will include banks, metals, infrastructure, media, realty, auto, consumer durables, hospitality and energy.
Due to high gains, the broad market and the best-performing stocks and sectors are vulnerable in the short term. We do not expect a big correction, since the undercurrent of the economy is still strong but we acknowledge the risk and think that a short consolidation will be good for the market. We suggest profit booking as a good strategy and to buy on dips, especially for traders and short-term investors.
In the coming week, the focus will be on IT sector as quarterly results have started. The third quarter is generally regarded as a weak one for IT companies due to seasonal furloughs. But this quarter is expected to be strong for Indian IT players, both on the growth and margins front. Companies that have good orderbooks are expected to see accelerated revenue growth with an increase in cloud adoption/digitisation and minimal impact of demand and supply side issues due to work from home (WFH).
Cross currency tailwinds will be moderate due to lower appreciation of EUR, GBP and AUD. The post result commentary is also expected to be strong, especially in the digital segment. However, we could see some delay in deal closures and decision-making due to uncertainty related to second/third waves of COVID-19 in certain geographies. We expect the IT sector companies to report USD revenue growth of +2.0 percent to +5.0 percent, on a QoQ basis, with 40-90bps positive cross-currency impact. Except wage hikes in certain companies, no other major cost increase is expected, leading to stable and rising margins for most of the players.
(Vinod Nair is the Head of Research at Geojit Financial Services.)
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