Stockmarket. With equities fairly priced in, investors have to moderate return expectations

In 2021, the equity markets witnessed extended gains amidst second wave of Covid-19 thanks to the prolonged accommodative monetary policy by the central banks across emerging as well as developed economies. Domestically, the second wave of pandemic receded during the second half of the year which resulted in the resumption of economic activities while the RBI continued to prioritize growth while keeping an eye on inflation.

As we prepare for 2022, there is reemergence of the pandemic in the form of third wave in Omicron. South Africa has seen one of the highest cases of the Omicron. However, the cases seems to have peaked without much increase in hospitalisation and death rates. India seems to have weathered the wave well, thanks to the proactive steps taken by the central and state governments to put necessary curbs in place. However, if still the cases go beyond control, we may witness another leg of lockdown/large disruption in economic activities. This may impact the markets adversely as was seen in March 2020.

Factors that can impact markets

FPIs have been booking profit after making stellar gains since the lows of March 2020. However, this may be a short term phenomenon as India continues to remain an attractive bet over the longer horizon. Further, the domestic investors have been absorbing the FPI selling. The market direction could be determined by the capacity of the domestic investors to absorb the FPI outflows.

Considering the valuation gap vs peers especially China, a few foreign brokerage houses have given a tactical short call on India. This view may very well change given that the fundamentals measured by Corporate Profitability to GDP ratio have improved substantially in FY 22 after having fallen from mid-single digit in FY 08 to low single digit in FY 20.

Globally, inflation and inflationary expectations have risen and the central banks led by the US Fed have indicated winding down of excessively soft monetary policy by reducing bond buying and indicating policy rate hikes throughout CY 22-23. The bond market, however, is betting against that through a flat yield curve. If the third wave intensifies, the central banks globally may be forced to prioritize growth over inflation. This may continue to aid the markets.

Severity of the third wave of pandemic, global inflation trajectory, the FPI activity and other factors would determine the market movement in 2022. From a short term perspective, Q3 results will be keenly watched and the corporate results should be ahead of market expectations. Markets may bottom if the earnings are better than expectations. Further, a growth supportive budget similar to the one announced in FY 21 shall make markets more attractive for the investors.

Stock selection is key

As the markets are trading at all-time highs, stock selection is going to be key. It may be prudent to avoid expensive stocks having low free float and concentrated holdings. A few themes like home improvement, engineering & capital goods, pharma and companies adopting to the digital ecosystem than peers is likely to out-perform in CY 22 and beyond. The big shall become bigger and therefore, industry leaders are likely to outperform their smaller peers.

The market is fairly priced and the investors would do well to moderate their return expectations. A prudent way to approach the markets is to be neutral in your allocation to equities with a bias towards large caps. There is likely to be volatility/corrections which an investor should be able to capture through disciplined asset allocation and a strategy to buy on dips.

Riding out market volatility is very similar to riding a roller coaster. So fasten your seatbelts and don’t leave the ride for an enjoyable experience!

The author is Group President & MD, Kotak Mahindra Asset Management Company

Disclaimer: Views expressed are personal and do not reflect the views of Kotak Mahindra Asset Management Company Limited.

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