Nifty At 13,000... Now What?
While markets may correct anytime, the deck is loaded in favour of those corrections being bought into, writes Niraj Shah.
♫ … I can picture every move that a man could make
Getting lost in her lovin’ is your first mistake ♫
These are the words of a song titled Sundown by Gordon Lightfoot, Canadian country music and rock artist. All these years when I heard this song, I never thought of the equity markets, until recently. It’s like advice coming from a rational person for someone who is bullish on the markets at the current juncture, asking the bull not to get lost in his love for the markets. Most bulls are currently getting that advice.
One common refrain that finds its way into every conversation is that the market is overheated and likely to correct. Some opinions make it sound as if it’s better for the market to do so. Reasons range from a second wave of Covid-19 in the western hemisphere, the fragility of the U.S. stimulus discussions, to fears of growth cooling off across the world. And while India’s GDP numbers are showing signs of limping back towards normalcy, the Indian market is tied to the hip with global markets. So, the skeptic argues correctly that the Nifty will correct if world markets correct.
Is there merit though, in examining the theory that instead of the rational person getting proven right, and the bulls getting lost in their love for the market, the bull may be triumphant? I am not saying ‘this time is different’, but merely that this may not necessarily be the moment of an apocalypse.
Before laying out the arguments in favour of the markets continuing their upward trajectory, let’s first study the reasons to be circumspect.
The swift nature of this rally has taken the frontline indices to all-time highs from multi-year lows. The Bank Nifty is almost at 52-week highs, cyclicals like autos and metals are charging ahead for multiple sessions at a stretch without taking any breather, the Midcap index is near two-year highs and if Laurance Balanco’s prediction is to be believed, the SmallCap index has given a breakout. Investors seem to have forgotten that there was an economy-halting event like Covid-19 just seven months back. All this makes the skeptic wary of the sharp up-move. However, this move can be a case of ‘Mr Market knowing best’. It is a forward looking animal, as all investors should be. And if one is an Indian market watcher, there are a few positives that are well worth keeping an eye on as you debate whether to exit at these levels or stay invested.
1. Global Factors
In a world awash with liquidity which finds very few avenues to park itself in, considering interest rates are near zero across the world, equity is gold (did anyone say Bitcoin?). Add to that factor, the dovish U.S. Fed is playing a known hand, and there exists a real possibility of some form of stimulus coming from the U.S. government and one would realise there are enough triggers to protect downsides and lead upsides. Known, but triggers nevertheless. And if we see a successful vaccine arrival, the pent-up demand for various goods and services will explode, driving rapid growth in sales and sentiment, for various industries. Also, at this time of the year, don’t forget the famous ‘Santa Claus rally’. For the S&P 500, in the last 70 years, there have been 52 instances of positive returns in December, and only 18 instances of negative returns. The probability is in favour of the investor who is bullish.
2. Earnings Growth In India, Finally!
The September-quarter corporate earnings season did something multiple previous quarters could not. Earnings beat estimates! Revenues rebounded at a faster pace than costs, which led to profit beats. With an upgrade (>5%) to downgrade ratio (<-5%) of nearly 4:1, as pegged by Motilal Oswal, this has by far been the best earnings season in many years. For a few brokerages, this has resulted in the first material earnings upgrade for Nifty EPS estimates in many years. The additional point is that corporate commentaries across multiple sectors seem to suggest continued demand recovery in Q3FY21 as well, underpinned by a healthy start to the festive season. All this leads to people believing that FY21 could be the year where earnings growth will beat estimates, a phenomenon more elusive than the aurora borealis.
3. A Favourable ‘Data Print’ Period
There are a few data prints that may disrupt the party, a key one being higher inflation numbers. However, the trends seem loaded in favour of a favourable macro data period for Indian markets in the near term. The GDP improvment may well look quite impressive in Q3. Remember, the RBI expects GDP growth to break into the black in Q4FY21. Couple that up with a favourable base of FY21 for the whole of FY22 reportage, one can see that we are entering a period of ‘better-looking’ growth.
4. No ‘Common Thread Across Major Tops’ This Time
A common thread in all the major tops in the past few years has been when high index levels are coupled with high valuations, high corporate profits, high leverage for corporates and market participants, and usually, large gains in the preceding years. One can make a safe argument that not many of these conditions stand fulfilled today. Valuations look optically high currently, but we are nowhere close to periods of high corporate profits or high leverage for Indian corporates. On both those counts, we may low, and in fact, may be on the cusp of an upcycle starting, due to the potential uptick in economic activity. And finally, we have not had large gains in the preceding years. Yes, there have been the occasional spurts, with annual returns of 3% in 2016, 29% in 2017, 3% in 2018, and 12% in 2019, but that is hardly eye-catching compared to the 5.6x return in the 2003-2007 period for the indices.
5. Valuations Stretched, But Liquidity Aplenty
When it comes to valuations, the price-to-earnings ratio is a bit like the vada pav of equity valuation. Smart minds might all know about more elegant, sophisticated, and nutritious alternatives. But everyone still chomps on PE multiples. As per a recent Goldman Sachs note, the two-year forward Nifty PE multiple is 2 standard deviations above mean, and thus, optically expensive. On FY21E EPS of about 500, the Nifty looks very expensive. But stretch the math to FY22, and the Indian market looks only moderately expensive, in a world gush with flows and favouring equities due to the lack of other investing options. Do note that in the month of November thus far, foreign investors have made the highest ever monthly-purchase of Indian stocks in at least two decades, if not more.
6. The Joker In The Pack: Lockdowns
The battle between longer-term vaccine hopes and the present lockdown reality continues to rage. The spate of vaccine announcements sparked a wave of euphoria in global markets, which fizzled away too, as surging infections and fading prospects of powerful fiscal stimulus kept the animal spirits on a leash. With most of Europe in partial lockdown and America quickly moving in that direction, market participants and economy watchers are trying to balance the probable brighter outlook for next year against the covid reality right now.
The market is a forward-looking beast, but the chart never rules out bouts of extreme volatility intermittently, which have the power to disrupt or permanently damage trading portfolios if positioned on the wrong side. But that is the trading view. The longer-term view, from the current vantage point, looks distinctly bright due to rates and growth.
To sum up, yes, the markets may correct anytime, but the deck is loaded in favor of those corrections being bought into. Investors, though, would do well to stay bottom-up, instead of pondering about market levels. The vaccine may likely bring the world back on its feet, and then businesses that can thrive in the post Covid tech-enabled world will be the ones that will find favour. People should bet on, and worry about, those, and not speculate on what after 13,000, because their portfolios have stocks of companies, and not Nifty Futures.
Niraj Shah is markets editor at BloombergQuint.