The Indian stock market is still potentially vulnerable in the absence of concrete evidence that the second wave has peaked, believes Christopher Wood, global head of equity strategy at Jefferies. Yet, he has increased his exposure to Indian equities in his relative-return portfolio – bringing it back to where it was at the end of last quarter.
The overweight in Indian equities, Wood said, will be increased by 2 percentage points (ppt) to 14 per cent. This will be paid for by cutting the weight in China by 0.5 ppt and Malaysia by 1.5 ppt. He had trimmed exposure to India earlier in April amid a sharp rise in Covid cases and its likely impact on the economy.
“On a more short-term basis, GREED & fear would have removed all exposure to India at the start of this month given the scale of the Covid second wave and the massive net foreign buying of Indian equities in recent months as investors reduced exposure to China and added to India,” Wood wrote in his weekly note to investors, GREED & fear.
Besides India, Wood has also upped exposure to Korea by 1 ppt, with the money raised by reducing the exposure in Indonesia and Pakistan by 0.5ppt each.
“The critical issue for India, and indeed the rest of the world, raised by the country’s second wave remains unanswered. That is whether the vaccines are effective against the new variant B.1.617 ravaging the sub-continent and now beginning to show up elsewhere,” Wood wrote.
That said, he also warns of the expensive valuation at which the Indian markets are trading at. The renewed mobility restrictions in India, he believes, also increase the potential risk of a renewed deterioration in asset quality for banks. Despite this, he remains optimistic on the Indian banking sector from a long-term perspective and recommends any marked pull back in India’s quality private sector banks as a buying opportunity, especially for those who missed the ‘explosive rally’ in banks from the lows reached in late March 2020.
“The Nifty Index now trades on 20.2x one-year forward earnings, compared with a ten-year average of 16x, though down from a peak of 22.3x reached in mid-January. One explanation is continuing hope that the government will not announce a national lockdown. A second is that many of those who panicked and sold during the national lockdown in the second quarter of last year probably missed the explosive rally off the bottom,” Wood said.
Asset quality issues
As regards the banking sector, asset quality issues in the first wave, according to analysts at Nomura, were contained with liquidity schemes and fiscal support to various parts of the economy. Banks, they believe, have built in elevated provisions to offset the impact now.
“Asset quality has surprisingly panned out better so far. Front-line banks have greater capacity to absorb asset quality losses, if any, from the second wave,” they said in a recent note.
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Another interesting point to note, according to Wood, is that the four largest private sector banks - HDFC Bank, ICICI Bank, Kotak Bank and Axis Bank – enjoy a growing share of deposits.
“The share of total system deposits by these four banks has increased from 11 per cent in fiscal 2020-11 (FY11) to 21 per cent in FY21 with the rise accelerating in recent years. This presumably reflects a flight to quality given issues in recent years surrounding the likes of Yes Bank,” he said.