Mr Market has a mind of its own and it often chooses to ignore who is on the throne

The Diwali week has started with a 'dhamaka' with the indices opening strong and crossing all-time high at the opening on November 9 and hitting a fresh record high of November 11, 2020. US election results strengthened the global positive sentiments as the Biden-Harris combine crossed the 270-seat mark. Locally, the steady improvement in businesses across sectors and the diminishing Covid-19 numbers have brought in the possibility of a faster than expected economic recovery.

Currently, we are at a situation where the sentiments are positive, economic data is showing positive trends, government support to the COVID situation is good, but the fast run-up in markets has left investors undecided on further deployment.

When assessing the expected trajectory of equity markets, one considers factors like sentiments, fund flows, growth expectations in manufacturing, services, and agriculture, government stance/support to the issues at hand, the valuations of stocks/markets and the possible risk factors on the horizon.

While the sentiments indicate a continued bull-run, the fund flow is likely to remain strong with possible improvements in the mutual fund contributions. FIIs have been bringing in the flows while mutual funds and domestic institutional investors are seeing a reduction in outflows. YTD, the FIIs have pumped in Rs 54,451 crore while the DIIs have pumped in around Rs 44,000 crore. MF SIP flows continue to be above Rs 7,700 crore per month.

While the sentiments are positive, the fundamentals too look to be steadily improving. Manufacturing Services and Agriculture are showing signs of recovery. The lead indicators like railway freight bookings, power consumption, highway vehicle movements, petrol and diesel consumption, metro cities traffic congestion and pollution levels, automobile sales, RTO transactions, crop sowing and farm equipment sales are all showing growth trends better and earlier than expected.

The Manufacturing Purchasing Managers Index (PMI) rose 3.7 percent in October’20 to touch a 10-year high of 58.9 and the Service PMI rose by 19.1 percent. GST collections for October’20 at INR 105,000 crores came in better than previous numbers. The RBI and Government implemented measures to ensure lower yields and credit availability and they stand ready to do more to support growth. The borrowing rates of the Government and good quality corporates remain lower than last year indicating a positive trend for quality borrowers. Rating upgrades to downgrades ratio of below 1 has shown a smart recovery from the Apr-Jun’20 levels.

USA elections, one of the major known risk events, is now behind us. Other risks such as a second wave of COVID-19 in India, like the one engulfing Europe and the US could well de-rail the economy and push it into another lock-down. This is a major risk that the world carries today and that could lead to fresh stress being built on growth and credit. Many small and medium industries have been very badly affected by job losses and business closures. Any further deterioration could be de-stabilizing.

On the valuations front, while the markets do look a tad overvalued, but the Nifty EPS in FY18 was at Rs 459 and in FY21, it is expected to be at Rs 485. We have seen three years of stagnant growth. Also, due to Covid19, most corporates have improved balance sheet strength by paring debt and reducing costs. This has resulted in better than expected Q2FY21 bottom-line growth in most sectors.

The coming Samvat year will start on a backdrop that has turned positive. The second wave could be a potential disruptor in the recovery, but its impact could be muted when compared to the impact the markets and industry saw in February / March 2020. While a 10-15 percent CAGR overall growth in corporate earnings can be expected by between FY 2021-23, paying a 31/32x trailing 12-month multiple seems expensive. But, the rebound in growth should not be under-estimated. Being optimistic in the long-term, selective in stocks and funds, monitoring portfolios frequently and taking tough decisions to cut exposures in underperforming segments should be the way to manage equity exposures during the coming year. Being under-invested in these markets could hurt more and the advice would be to be 70-80 percent invested with 20-30 percent held as ‘dry-powder’ to be able to average down in case of sharp dips in the markets.