March 2021 Stock Market Outlook

Last Updated on April 7, 2021

Review

For the year ending Jan’21, Nifty TRI closed at 20,645, around 31% higher than last year. In the last 3 years, Nifty TRI is up 44% translating into ~13% CAGR.

Out of the total 31% return last 1 year, 14% of the returns came from four stocks HDFC Bank (3.3%), Infosys (4.1%), Reliance Ind (5.3%), and TCS (2.2%).

Low-interest rates globally and optimism around vaccines have led to new highs for Nifty. The recent rally is led by cyclical stocks that were beaten down due to uncertainty about economic recovery.

Incremental macro data suggests an improvement in economic activity and better utilization. Pro expansionary Budget announced on Feb 1, 2021, further lead to a rally in the cyclical and infrastructure sector as they could benefit from the government’s focus on investments.

After a long time, the asset-heavy companies and cyclical stocks have better-expected growth rates on a low base, versus growth stocks. We are seeing sharp rallies in various cyclical. A lot of companies have new capacity coming online or utilization is increasing on a low basis.

Outlook

As of date, the average upside of our coverage universe is likely to be less than 10% CAGR over the next 3 years basis based on current estimates. The valuation of companies goes up every quarter if the company reports growth in earnings. This can improve the upside potential of stocks. 

If we see growth improving next year, we may see an upward revision in our estimates. We have made upward revisions in sectors where we are seeing a sustained recovery in earnings and cash flows.

Nifty 50 index trades above its fair value while there are pockets of extreme overvaluation and undervaluation. Nifty – led by a concentrated portfolio of Top 10 stocks – is around 21% higher than its fair price, not true for all stocks. (Nifty@MRP 11,864)

We are looking at opportunities in infrastructure, building materials, export-oriented chemicals, PSUs, and import substitute ideas. We have incrementally added stocks in capital goods and Infrastructure as we started seeing sustained growth versus volatile growth earlier. We recently added two good quality companies in the logistics space.

We look at companies that have good earning triggers over the next 2 years as we are not certain whether broad-based recovery will happen immediately. We are investing in companies i) coming out of sector consolidation/debt reduction, or ii) introducing new products, or iii) commissioning new capacities, or iv) executing orders in hand. This gives certainty of growth rather than plain anticipation or, v) Export-oriented companies as economic recovery is better in western countries.

Investors have to ensure their stocks have good growth prospects, high return on capital employed, and reasonable valuation. Currently, all these factors are present in building materials, Pharma, IT, utilities, select capital goods, and infrastructure.

Risks

Indian Economy

GDP data saw two-quarters of year-on-year decline, while the recent quarter was more reasonable 7.5% versus the previous quarter decline of 23%. Fortunately, the cases have subsided and fear of the second wave is receding.

Auto sales are robust in pockets, however, vehicle registration has fallen for two consecutive quarters Jan’21 & Feb’21. Also, disruption in semiconductor shortage may affect Auto production numbers which don’t reflect any insight into economic recovery.

There is good demand for cement and steel and power. Electricity consumption has been consistently growing since Oct’20 indicating pick-up industrial activity.

Rising oil prices are a risk as oil-producing countries are cutting supply leading to price rises. Fiscal Deficit in FY21 and FY22 is likely to be elevated versus long-term range which can lead to a sharp rise in bond yield affecting equity and bond prices.

Inflation from rising commodity and oil prices can spark fear in economic recovery. However, without job/income growth and under-utilized capacities in the various sectors make the fears of inflation transitionary in nature for now.

Global Economy

Western countries are reporting better outlooks as vaccination is picking up pace. This can lead to economic recovery over the next 6 months. Large stimulus checks are handed over to citizens has led to cash flowing into bank accounts. As people get vaccinated, they will spend this on shopping and traveling. This will help in economic recovery.

Economic recovery means a positive sign. This is leading to falling in gold prices and bond prices as investors sell off their defensive positions. At the same time stretched balance sheet of the US government is causing investors to ask for higher yields, hence a fall in bond prices.

Offlate there are signs of speculative fervor in US markets and Cryptocurrencies. A lot of trading activity has led to an increase in leverage and higher trading volume. The rising interest rate will cause restrictions on speculative activity. There is a risk of synchronous global market correction at some point.

Frequently Asked Questions

Shall we stay invested or sell equity?

Odds are highly in favor of staying invested rather than exiting or delaying fresh addition.

For fresh funds, we recommend 50-75% investment into stocks/funds that will do well over the next 5 years. If your time horizon is long term, the current valuation will make lower sense as the law of averages will take your returns higher. Here is one such exercise:

Nifty is indeed 20% expensive versus fair value. If Nifty is likely to earn 13% CAGR returns over the next 10 years, buying 20% above fair value reduces your returns by 2% CAGR i.e. it will earn 11% CAGR versus 13% CAGR. Now it doesn’t look so bad.

If Nifty were to give 13% CAGR returns over the next 20 years, buying 20% above fair value reduces your returns by 1% CAGR i.e. it will earn 12% CAGR versus 13% CAGR.

Is the market rally overdone, are we up for deep correction?

We think that compared to the US, Indian markets haven’t done much over the last 5 years to fear prolonged correction. India has been in downcycle for the last 5-8 years and it still has below-average corporate profits to GDP. This means that even if the Indian market will correct with global markets, all markets move together in short term, there are higher chances Indian markets will recover faster. Besides, Govt pro-business outlook has further put a floor to valuation.

We have seen quite a few Indian investors very fearful during the rally from lows. This is the nature of the market to rise and fall in quick succession. We advise looking at long-term returns of the market to see whether we are in bubble territory. Given our last 5 years or 10 years, returns are similar versus average long-term returns (12-13% CAGR), we do not seem to be in bubble territory. This reduces the risk of very poor returns from the current price.

What sectors may do well over the next 3-5 years?

In long term (5 years+), or even medium-term (3 years), stock prices go up in lines with earnings growth and valuation. Even if there is volatility in the interim, the stock prices of good companies recover to match respective earning growth.

We believe that the current market has opportunities in the manufacturing and infrastructure/housing sector. Lower interest rate, pent-up demand, PLI scheme, rising commodity prices are very favorable for these sectors.  

Every cycle has different sectors that perform well. We believe that favorable valuation and earning growth are two positives for manufacturing and infrastructure stocks.

We recommend equity investing only for long-term savings so that near-term events become irrelevant. We do not find any merit in second-guessing what’s going to happen in the next 6 months-1 year. If the shortlisted stocks are good companies, with good growth prospects, they will deliver returns in line with business performance. Picking the right stocks is easier than predicting the market direction.

We continue to recommend Gold Fund/Gold (up to 5-10% of the portfolio) as a hedge from contagion risks.

Avoid any type of regret while investing. Regret can come from either missing stock or not adding enough to a winning stock. Rather focus on overall strategy as explained above.

Do not disturb equity allocation in your asset allocation. At best you can increase/reduce 5-10%. Beyond this, tinkering with asset allocation will only reduce long-term returns or increase risks thereby missing one’s target corpus.

We have diversified our stocks portfolio, we have diversified assets and we have a long-term horizon. Together this takes care of all potential risks in investing.

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