Markets in a vulnerable zone, full-fledged bear phase less likely: Analysts

Those at Motilal Oswal caution against the possible earnings downgrades going ahead due to the mobility restrictions, which they believe has 'muddied sentiment and impaired FY22 earnings visibility

Equity market is in a ‘vulnerable zone’ and are likely to remain very volatile, impacted by the sharp rise in Covid cases in the country since the past few weeks that has seen many state governments impose lockdowns and mobility restrictions to check the rampant spread, said analysts at HSBC in a recent report. They, however, have ruled out a deep correction for now. 

From a medium-to-long term perspective, however, most analysts remain bullish about the markets but do caution against the possible earnings downgrades given the sporadic lockdowns and expensive valuation. While lockdowns can weigh on growth expectations in the near term, acceleration of vaccine drives and overall direction of active cases will still act as the key catalyst for the market.

“The Indian market has experienced around 6 such phases in the past 15 years, which are precipitated by key events but don’t end up being sustained bearish phases, where the median fall of the market has been up to around 15 per cent, and lasting around three months,” wrote Herald van der Linde, head of equity strategy for Asia Pacific at HSBC in a coauthored note with Amit Sachdeva and Anurag Dayal.

“The market fall during the first Covid wave was quite steep with a broad-based sell-off that saw the Nifty tumble around 38 per cent between January – March 2020, reflecting the level of uncertainty in the market. Once the situation improved, the market demonstrated a strong recovery, even crossing pre-COVID-19 highs, led by faster-than-expected recovery momentum seen across the board. Having learnt its lesson, the market has been pretty resilient during the second phase, with the Nifty50 down around 5 per cent from its February 2021 high,” Linde said.

Compared to their global peers, Indian bourses have underperformed this far in calendar year 2021 (CY21), rising around 5 per cent during this period amid rising Covid infections back home and surging bond yields globally. Most developed markets have gained around 14 - 15 per cent.

“The moderation in US 10-year yields to sub 1.6 per cent along with renewed weakening in US dollar index closer to 90 and persistent softening in market risk premium, denoted by CBOE VIX index to 19 levels represent a positive combination for equities,” wrote Dhananjay Sinha of JM Financial in a recent note.

Investment strategy

During this ‘vulnerable phase’ for the markets, HSBC suggests focusing on four themes – stocks that were underperformers in 2020, offer defensiveness and resilient earnings outlook; those that are disrupted by COVID-19, trade at attractive valuation, offer long-term attractiveness and where risk-reward remains favourable; those stocks and sectors that are Covid beneficiaries due to consumer preferences or changes in industry structures; and are long-term structural winners, though may see some correction in the near-term due to past outperformance.

“Hindustan Unilever (HUL), Bharti Airtel, Axis Bank can act as defensive and relative underperformers; Indian Hotels and Prestige as disrupted plays with attractive risk reward; Titan, ICICI Bank, Asian Paints, Bajaj Auto, Bajaj Finance as structural winners; and IPCA, Cipla and Marico as beneficiaries post Covid. Our analysts rate all these stocks as Buys,” HSBC said.

Those at Motilal Oswal, however, caution against the possible earnings downgrades going ahead due to the mobility restrictions, which they believe has ‘muddied sentiment and impaired the fiscal 2021-22 (FY22) earnings visibility. That apart, valuation are also a concern. 

“We see downside risks to our FY22 earnings estimates. March 2021 quarter (Q4-FY21) earnings are progressing largely in line with our expectations, but management commentaries in BFSI / Consumer / Auto have turned cautious. The Nifty now trades at 12-month forward price earnings (P/E) of 19.4x, around 3 per cent above its historical average of 18.8x. At 2.9x, Nifty P/B is well above its historical average of 2.6x,” said Gautam Duggad, head of institutional research at Motilal Oswal Securities.

Among sectors, Duggad remains overweight on BFSI, IT, Metals and Cement; Neutral on Consumer, Healthcare, Auto, Telecom and underweight on oil & gas and Infrastructure.

Historical perspective