Editorial

Cautious optimism

| Updated on January 03, 2021 Published on January 03, 2021

Markets are riding on hopes of quick economic revival, but it is best to temper expectations

The Indian stock market has proved to be among the most resilient in 2020, closing the year with sizeable gains. It would however be difficult to replicate this performance in 2021 as current price levels seem to have already factored in a strong recovery in the economy as well as corporate earnings in 2021 and 2022. This not only limits further increase in stock prices but also any disappointment or setbacks can bring forth a flood of profit-taking. The Indian stock market was among the best performers from the bottom touched in March 2020, when panic triggered by the economic consequences of the Covid-19 pandemic dragged stocks sharply lower. While stocks were initially lifted due to the humongous stimulus funding announced by all countries, Indian equities were particularly favoured by foreign portfolio investors last year and their net purchases amounting to ₹1,68,000 crore of Indian stocks was largely instrumental in taking the benchmarks beyond pre-Covid-peaks. The benchmark indices have managed to gain 15 per cent last year while the mid- and small-cap indices have managed higher gains, as the rally became more broad-based in the last quarter of 2020.

Besides FPIs, Indian stocks also witnessed good demand from domestic retail investors and HNIs who increased their activities in Indian stocks, due to the surplus time on their hands caused by work-from-home and the lockdown. While the rally appeared incongruous in the second quarter of 2020, when economic activity was at a standstill and GDP contracted sharply, the optimism displayed in stock prices was vindicated by the subsequent recovery in economic activity. Corporate earnings, after a severe contraction in the June 2020 quarter, recorded remarkable recovery in September quarter, thanks to cost controls, lower interest cost and taxes. However it is a little worrying that the market is currently pricing-in a sharp recovery in earnings growth in FY22 and FY23. Given that the consensus forward estimate of earnings has always been too optimistic calling for a downgrade at a later date, it is not right to justify current prices based on future growth estimates. The buying has also been concentrated in healthcare and IT stocks with both these indices gaining over 50 per cent in 2020. The rush towards stocks that have a sustained record of high earnings growth and return on equity, has resulted in excessive valuation.

While liquidity could continue to be supportive, volatility cannot be ruled out. There are other uncertainties, such as the time it will take for the pandemic to die down sufficiently to allow economic activity to reach pre-Covid levels; Biden’s proposed corporate and income tax rate hikes; the hidden stress in the banking sector; and lack of public and private capital expenditure. Investors should moderate their expectations from stocks this year, even as they continue to invest for the long-term.

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Published on January 03, 2021
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