Based on positive data concerning vaccine development, the Nifty and the Sensex gained over 11% each, aided by record FPI inflows of around USD 8 bn, even as local institutions were heavy sellers during the month. Market breadth improved considerably as Mid caps (15.5%) and Small caps (12.96%) outperformed Large caps.
Indian stocks were also aided by better than expected corporate earnings as margin expansion resulted in double-digit profit growth on better cost controls by corporates, comfortably offsetting the decline in revenues. Also, providing support was earnings upgrades that continue at an unprecedented pace as activity continues to normalize.
Along with the earnings upgrades, India also experienced upgrades to GDP estimates. Q2 GDP saw a lesser contraction at 7.5% viz-a-viz 9-10% estimated levels. Indian economy and corporate earnings surely are on the road to Recovery. However, whether the trajectory continues to improve post festive season needs to be closely monitored.
On the Global front, a decisive Presidential election verdict in the US, and positive news flows concerning Covid vaccine development led to global risk assets rallying over the past month, pricing in an earlier resumption of normal economic activity.
On the domestic front, positive surprises on macro-economic revival and Corporate earnings coupled with lower incremental Covid cases has pumped up the equity markets. And with recent earnings upgrades, a weak dollar, and lower interest rates may keep foreign flows supportive.
Post March 2020, there were expectations of a significant earnings downgrade. However, corporate earnings have not been as bad as expected which has resulted in a lesser contraction in earnings from pre-Covid levels and subsequent upgrades.
But the current exorbitant valuations at 36.5x on a TTM basis and 24.2x on 1yr forward basis discount significant and continuous expectations of earnings of which we are not sure yet and hence, extreme caution is advised to investors.
Hence we believe that the equity markets may remain highly volatile, and we continue with our cash call due to a lack of concrete evidence of a strong recovery.
On the Fixed Income front, inflation remaining consistently above its upper target of 6%, the RBI has to find a way to balance between prioritizing economic growth and controlling inflation. In its last MPC meeting, the RBI kept the Repo rate unchanged at 4% while pledging to maintain an accommodative policy stance well into the next financial year to support economic recovery.
To control inflation, The RBI has to suck out the excess liquidity, which means it cannot buy the excess dollar inflows and allow the currency to appreciate.
Given the excess liquidity on the shorter end of the yield curve, the government bond yield curve is likely to remain steep. The RBI is committed to supporting the market, but as we are towards the fag end of the rate cut cycle, it will be prudent to be on the shorter end of the yield curve for lesser volatility risk than longer maturity exposures.
For investments, we believe that exposure to debt markets should be taken through short term funds for a 1-2 year investment period and Banking and PSU debt funds for more than 2 year investment period.
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