'Markets are in the midst of figuring out the impact of the 2nd Covid wave'

While the market has weakened from its high, it is up significantly over the year, and is trading at multiples that are well above its mean, says Aditya Narain of Edelweiss

The bears seem to be tightening their grip on the markets amid a sharp rise in Covid cases across the country. ADITYA NARAIN, head research – institutional equities at Edelweiss Securities, tells Puneet Wadhwa in an interview that going ahead, corporate earnings’ estimates could get trimmed, given the ferocity of the second wave, and importantly its spread, beyond urban areas. Edited excerpts:

Do you think that the markets are now looking beyond the second Covid wave and its impact on the economy?

The markets are in the midst of figuring out the impact of the second wave. The backdrop of the markets thinking would very much be the experiences of the US and European markets – which rebounded as the second wave starting unwinding. But India’s second wave is sharper, and to that extent, the market will look harder at how the market will play through. It’s also important to keep in mind that, in hindsight, the first way was primarily about a supply squeeze – the demand impact was relatively limited. The second wave in India is different - there is not much of a supply issue, but demand could well more of an issue, at least till the second wave fully ebbs.

How are the markets seeing the outcome of the recent assembly polls? 

The second wave, its trajectory, will be more dominant and overriding drivers, than the swings with the elections. That said, given the level of disruption that has been caused by the second Covid wave, combined with the election results – the possibility of more aggressive policy action particularly on investments for medical and infrastructure support increases. This just might just provide a certain government / corporate sector spend / investment endeavor (a kind of reimagine and reinvest endeavor – in evidence in the US): which could be a trigger for greater spends and structural optimism, which the market might not be looking at. 

What are the triggers that can pull the markets on the either side?

One of the primary factors, in the intermediate term, will be how the second wave recedes. This will be a dominant driver. Going beyond, the triggers will tend to be global market cues, global flows - with possibly more downside than upside risks, and policy measures that might come through to support the economy given the second surge. While the earnings reporting cycle is  important, the market will see them as  backward looking – and weigh more on management commentaries, though I see those largely holding steady, but a little more cautious in expression. One also needs to be cognizant of the fact that while the market has weakened from its high, it is up significantly over the year, and is trading at multiples that are well above its mean.

It was Reliance Industries, followed by financials that led the market rally in 2020. Are there any such stocks / sectors that can do so in 2021?

I do not believe one will see the kind of singe stock or group dominance that one might have witnessed earlier – a higher market level and more predictable and normalised expectations usually limit such sharp trends. That said, there will be greater momentum with the cyclicals – financials and industrials – as the economy starts getting back on a growth path, and the backdrop of cheaper and more easily available money. We do also see the information technology (IT) and technology spaces as a more structural tailwind that will continue to lend market leadership. Insurance businesses can be a beneficiary of their own efficiency gains, and a pandemic precipitated shift to the products, as one of the leaders for the market.

And the ones to avoid?

We are a little cautious on the discretionary demand sectors – auto and to some extent the consumer non-durable space, where the lockdowns and the non-essential spend damage that the second wave is inflicting, could push out demand. Our prominent structural call will reside with the IT services space: better global demand, and improving economics, which should provide resilience to any investment portfolio.

Will FY22 earnings estimates be downgraded going ahead as Covid 2nd wave dents economic recovery?

March 2021 quarter (Q4-FY21) numbers have been good (albeit there always was going to be the base effect tailwind) – barring some commodity price hits. It’s also important to note that bank asset quality numbers were stable, and comforting, and that makes a material difference beyond the profit & loss (P&L). I would believe there would be some trimming of estimates, given the ferocity of the second wave, and importantly its spread, beyond urban areas. That said, I do not believe the broader economic trend is broken - it does get pushed back in a quarter or too, which could play through in market estimate trims, and possibly a little more so for the discretionary part of the earnings pie.

Are the fears of a further spike in bond yields firmly behind us?

We believe the overhang and uncertainty of global central banks will remain a constant in the post pandemic cycle: for equity markets in general, and India will be part of that. Strong commodity prices, and the possibility of near term inflation, could well see the markets getting spooked every now and then. That said, the commitments to getting Western economies back on track – from Governments and their Central banks, appear fairly complete to us, and that suggests any unwind, if any, will only be orderly, and unlikely to disrupt markets meaningfully. The same applies domestically to India – and with the second wave likely to lead to some disruptions – an easier for longer monetary approach is likely to sustain in India. So, the possibilities of monetary policy reversals might be a little bit of an overhang for the upside, but unlikely to be a dominant downside risk.

Off late, Indian markets have somewhat decoupled from the global peers. Do you see a reversal in this trend any time soon?

The decoupling is not a function of economic or corporate data – but more of the timing and extent of India’s second wave, and the global markets increasing awareness of it, psychologically, and visually. That, and the disproportionally higher global capital that has moved into India since the pandemic – on an absolute, and relative to EM, basis. This does suggest that India probably faces more downside than upside risks, in the immediate term. That corporate and macro data has been positive – the latest GST data a case in point; suggests that if that’s not too disrupted, than the recoupling might not take too long to happen. A lot will also depend on the trajectory of the second wave – an early peaking would help, given that markets would look for a peaking, rather than its end. India’s supply side – and transportation has remained opened in this lockdown versus the previous one, does limit the dislocation to demand and its trajectory, unlike the last time.    

How's the mood among your clients/foreign investors regarding equities as an asset class?

Equities does remain a relatively favored asset class amongst investors. It is obviously helped by recent performance, but more by the quicker than expected economic recoveries that most developed economies are seeing, the acceleration of vaccines and opening up of markets that is increasingly visible, and the policy support that sustains ( the US’s fiscal push is the very latest in that direction). India continues to get prominence amongst EM’s and it is likely to stay that way, but the EM’s are lagging the  developed world in their economic responses, and vaccination pace – and that could mean that 2021 could well be more of a developed markets (DM) story, than was the expectation immediately post the pandemic in 2020.