Benchmark indices Sensex and Nifty have touched new highs despite macroeconomic concerns. What are the reasons for this?
2020 has been a roller coaster year for the equity markets and we have witnessed various legs of market performance, driven by multiple factors and variables. After the sharp market correction through February and March, the markets bottomed out in the last week of March.
As a result of the sharp correction, the first leg of recovery was driven by attractive valuations and led by sectors that were assessed to do relatively better in an uncertain environment. The second leg of the rally (which started from about third week of May), was driven by optimism around the reopening of the economy, pent-up demand and rebound in economic activity indicators. The next leg of the rally that started from September onwards witnessed much broader based rally and further pick-up in sector rotation and catching up of the laggard trends. The better than expected financial performance of the companies supported the market recovery.
As a result, the recovery in equity market through 2020 has been driven by attractive valuations, faster than anticipated recovery post lockdown, reopening optimism (with strong earnings rebound estimated for FY22), swifter than expected vaccine intervention and above all, the unprecedented liquidity.
Your outlook for 2021
As we look ahead and visualize up the outlook for next year, two key variables that shaped up the equity rally during 2020 - global liquidity and lower interest rates are here to stay. In addition, the recovery process from the covid-19 disruption will continue, leading to significant economic GDP rebound and corporate earnings growth (~40%) in FY22.
As we approach the new year, while we believe that the recovery process will continue to play out but owing to the heightened consensus expectations, the room for positive surprises could potentially narrow. However, such a scenario presents itself an opportunity by focusing on themes / sectors that can deliver positive surprises in revenue / earnings in the coming year leading to upgrades in consensus estimates. So despite the sharp rally through 2020, by having a bottom up approach which focuses on names that can deliver positive earnings surprises, there will be still scope for equity outperformance.
But as we are speaking about the equity asset class, the longer time frame should be emphasized more and that is a much better canvas to work with at this juncture. A sustained period of lower cost of capital coupled with low real rates, sets up a fertile ground for equity to continue to flourish as a preferred asset class. Risks to this thesis is in the form of any permanent demand dislocation or slower demand recovery that potentially further delays the private capex cycle. Also, global liquidity being withdrawn early and lack of further stimuli in developed markets could hamper the optimism and adversely impact flows to EMs. The vaccine timelines (for production and distribution) will be closely followed and the efficacy and execution of the vaccination program will influence the market performance during 2021.
Sectors to watch out for in 2021
Sectors and companies that can provide positive earnings surprises would continue to do well and outperform in the coming year.
We believe that financials and real estate top the list while healthcare also has the potential to spring up a few earnings surprises. In financials (specifically in private banks), we believe that the earnings surprises will be driven by lower than expected credit costs coupled with recovery in credit growth. In real estate it will be driven by demand factors (residential affordability) and industry consolidation benefiting the larger listed players. Telecom is another sector where we are positive and this is driven by the expectation of the time being ripe for a tariff hike cycle, which can potentially lead to earnings upgrades as market expectations have got moderated given the inordinate delay on this front. Technology is another sector that we like. Near term acceleration in revenue growth is adequately captured in current stock price. But if the current trend of digital adoption and “migration to cloud” were to gain momentum (and we think that it will) then growth over medium term will accelerate further. Thus technology is a “Buy on dips” sector for us.
Which category of funds should MFDs recommend at this juncture
Within equity funds and in-line with our thought process that given the sharp rally already seen, market is likely to reward positive earnings surprises more. Hence, a bottom-up approach to stock picking could provide more rewards compared to a top down or a broad based approach as it will provide flexibility for portfolio managers to pick and choose ideas. True to label flexi-cap funds could enable the investors with such an opportunity being sector agnostic in nature and also focusing on the bottom up ideas rather than following a specific or predefined allocation plan.
