After a stupendous rally in market, returns may moderate in 2021: Experts

Experts say markets have already priced in a lot of positives

After a stupendous rally in the market from March lows, experts say returns may moderate in the new year. The market's trajectory in the calendar year 2021 (CY21), they believe, will be guided more by developments surrounding Covid-19 and its vaccine, oil prices, global central bank policies, and the US dollar's movement at the global level.

Back home, corporate earnings and the government's policies to revive economic growth (within and outside the scope of the Budget) amid rising inflation will be keenly watched.

The expectations of moderate returns are linked to the fact that the markets are currently pricing in a lot of positives as they enter 2021 at record highs.

The Nifty50 and Sensex targets of some brokerages for 2021 (see table) also indicate just 5-7 per cent upside from the current levels, compared to about 15 per cent delivered by these benchmarks in 2020 thus far.

ICICI Securities, for instance, expects the Nifty50 to hit 14,900 levels in 2021 in a bull-case scenario. “However, if market bullishness reverts to average sentiment, the base case fundamental value is around 13,500, which indicates flat returns for CY21,” wrote Vinod Karki and Siddharth Gupta of ICICI Securities in a December 22 note. But, if a risk-off environment materialises, they expect Nifty50 to touch 11,600 on the downside.

Interestingly, even though the new virus strain has triggered a fresh wave of lockdowns across major European cities and created a flutter in global financial markets recently, analysts say the vaccines should be able to counter the impact and the markets should stabilise soon.

“The ‘big’ difference this time is that there are vaccines being rolled out and therefore the narrative is that it is only a matter of time before we get through this virus,” explains Andrew Holland, chief executive officer at Avendus Capital Alternate Strategies. “So, throw in more government and central bank stimulus throughout the first half of 2021 and the outlook for both the global economy and markets looks positive,” adds Holland.

From their March 2020 lows, the S&P BSE Sensex and the Nifty50 have gained 83 per cent each. While mid-caps have risen in line with the leading indices, small-caps have seen a sharper surge of 102.5 per cent during this period. A large part of this broad rally has been on account of the gush of liquidity from foreign institutional investors, who have invested Rs 1.66 trillion thus far in CY20.

Jigar Shah, chief executive officer at Maybank Kim Eng Securities, who believes that the frontline indices are overvalued, says, “As long as the ultra-low interest rates continue, foreign flows, too, would continue to flood the emerging markets (EM). India being a large market with diverse sector/stock opportunities, flows are likely to be robust in 2021.” Much of these flows, he adds, could go into the primary market than the secondary market, into REITs, InvITs and other such instruments.

Valuation-wise, the Nifty50 index is currently trading at a one-year blended forward price-to-earnings (PE) multiple of 22.3 compared with its 10-year average of 15.8 and 5-year average of 17.5. At the start of 2020, the PE multiple was 18.2.

Corporate earnings: A key trigger

Apart from liquidity, another key driver for the markets in 2021 will be how soon corporate earnings beat pre-Covid-19 levels.

Earnings in the July-September 2020 quarter (Q2FY21) got a boost from lower raw material prices and cost-cutting measures adopted by companies in the backdrop of the Covid-19 pandemic, and surprised the Street. But, sustaining the surprise may not be easy. If Sensex/Nifty earnings rise by over 30 per cent in FY22, as estimated by brokerages, valuations would turn reasonable.

Analysts believe earnings growth over FY20-23 will largely be driven by normalising depressed earnings in corporate banks, telecom, auto, commodities and pharma sectors.

Neelkanth Mishra, managing director, co-head of Asia Pacific Strategy and India equity strategist at Credit Suisse, believes that Indian equities are no longer cheap: on PE versus their own history, relative to global and EM equities, and versus domestic bond yields.

“We find the near-term cyclical recovery to be priced in. Market upside may only come from upgrades to FY23 EPS, and better medium-term growth prospects,” Mishra wrote in a note earlier this month.

Some experts, however, believe that there will be pockets that will stand out as the bullish sentiment spreads.

With Indian economy set for a sharp rebound in 2021, Holland believes the market returns will become increasingly broad-based with banking, industrials, energy and consumer discretionary to lead the markets. The other more thematic growth areas can be healthcare and telecom.

Shah of Maybank, on the other hand, expects sector rotation to be a big theme in 2021. Software services, pharmaceuticals, telecom, cement, private banks, are likely to outperform, according to him.

Key risks

Steadily rising inflation and oil prices are key worries for India’s fiscal health and markets. From a low of $17 a barrel in April 2020, Brent crude has surged 195 per cent to $51.2.

According to Barclays' estimates, a $10/barrel increase in oil price (implies Rs 5.8 per litre increase at the pump) would add 34 basis point to headline inflation over 3-6 months, assuming no change to petroleum taxes.

“Not only crude oil, but prices of most metals and vegetables are rising. 2021 could see both demand and supply-side pressures. All this will weigh on the already fragile economy,” cautions G Chokkalingam, founder and chief investment officer at Equinomics Research.

The stock market, as of now, is ignorant of this and is driven more by liquidity. Sooner or later, the markets will realise the stark reality, adds Chokkalingam.