October 2021 Stock Market Outlook

Outlook Podcast:

Review

For the year ending Sept’21, Nifty closed at ~17,618, up 54% from last year. In the last 3 years, Nifty is up 61%; ~17% CAGR.

The last 1 year saw a massive shift in stock performance versus the prior 2 years where only Nifty stayed flat while the rest of the market saw correction. In the last 1 year, every segment of the market, small, mid, value, cyclical did better than Nifty. Low-interest rates globally and high investor participation in the global market have led to good gains in stocks.

Performance of Real Estate, Consumer durables, and PSU stocks was very good in the previous month.

Here is the list of best-performing stocks, Year-to-date:

Accelerated economic recovery across the sectors is exciting the market. The clampdown on Chinese companies by the Chinese government has rattled the Chinese stock market which might be leading to foreign funds flowing into India. Also, monthly inflows and SIP registrations have touched all-time highs in the previous month leading to stellar gains offlate.

Celebrating SENSEX at 60,000!!!

Sensex has hit 60,000 on 24^th September 2021. Every 10,000 points of Sensex is some sort of milestone when it comes to equity investing. It is a celebration of wealth creation and entrepreneurial success.

Every 10,000 climb has been special as it is achieved at a faster pace than before. For recent 10,000 pts, it took just 4 months and just 20% gain.

From 30,000 in 2015, Sensex nearly doubled to 60,000 in 2021. We looked deeper to see which stocks contributed to such a mammoth move in Sensex in 6 years.

Sensex’s move from 30,000 to 60,000 has been quite concentrated by a handful of stocks leading to the bulk of the returns in the last 6 years. The top 10 stocks were responsible for 73% of the move (22,123 pts) in Sensex in the last 6 years.

The highest return has come from Infosys, Reliance, TCS, HDFC Ltd, and ICICI Bank which contributed almost 50% in total 100% return.

Future winners will be different

We expect different companies all together to lead to the performance of Sensex/Nifty over the next 5 years. History shows that stocks that performed in the past lag in subsequent years.

Top 10 Nifty stocks across 1995, 2005, 2007, 2010, 2021; Source: NSE

The above table shows different stocks that perform from one period to another and become part of the top 10 stocks.

• 1995-2005: Performing Sectors: IT, telecom, and oil. (New entrants: Infosys, TCS, Wipro, Airtel, TCS)
• 2005-2007: Performing Sectors: Infra, Power, and Metals (New entrants: NTPC, BHEL, SAIL)
• 2007-2015: Performing Sectors: HDFC twins & Pharma (New entrants: HDFC, HDFC Bank, Sun Pharma)
• 2015-2021: Performing Sectors: Banking and FMCG (New entrants: Kotak & HUL)

This means that the past winner stocks underperformed and ranked below.

Past data reveals that out of the 50 stocks in Nifty, just thirteen companies have been a part of the index’s journey since inception (Source: Motilal Oswal).

This means that very few companies continue to outperform Nifty. If they do not perform, they are removed. It is not enough to shortlist just a handful of companies and sit tight. You have to follow disciplined investing, stay with stocks/sectors delivering good earnings growth, and respect valuation.

We continue to advise our clients to stay invested in the market. You may switch between stocks that have a poor risk-reward scenario or wait till a reasonably priced stock comes by. We expect a pick-up in growth in economy-sensitive sectors like capital goods, real estate & allied sectors, power, banking, logistics, and infra and allied sectors. Potential winners of the next 5 years will be from these sectors.

Outlook

Nifty 50 index trades ~30% 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 30% higher than its fair price, while the same is not true for all stocks. (Nifty@MRP 13,129 Jun’21). The next update will be done after we incorporate the December Quarter results.

We are seeing a recovery in growth in the coming year so we may see an upward revision in our estimates. This can bring down overvaluation down by ~5-10%.

As of date, the average upside of our coverage universe is likely to be closer to 10% CAGR over the next 5 years basis based on a current estimate. Similar to Nifty, the average upside of our universe is low due to few stocks showing < 0% CAGR while the rest showing > 15% CAGR upside potential.

Today, we are looking at opportunities in infrastructure, building materials, export-oriented capital goods, PSUs, and import substitute ideas. We continue to remain positive on existing companies that are delivering good growth. We are benefiting from early investments in building materials, industrials. Optimistic outlook on real estate and increase in order flows has led to a rally in infra and infra-related stocks. We have added stocks in the industrials segment as we expect balance sheet strength to improve and cash flow growth will be better than past.

Stocks in IT and Pharma have moved up ahead of their earnings growth, we are reducing our allocation in the same.

We look at companies that have good earning triggers over the next 2 years. 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. v) Export-oriented companies as economic recovery is better in western countries. This gives certainty of growth rather than plain anticipation.

Caution

We recommend avoiding stocks/sectors that have run up much ahead of their earnings growth over the last 3-4 years. We observe many small and mid-cap stocks have run ahead of valuation as non-institutional participation has led to excesses in few pockets. We reduced allocation to few mid and small caps where prices have run up ahead of earnings growth.

We recommend treading cautiously in small caps where sales figures are below 2019 levels but may optically look at high growth today on a low base of 2020. We recommend using FY19-20 sales as a base while evaluating growth or valuation. (Compute P/E ratio using EPS of 2019/20, Compute P/S ratio using Sales of 2019/20). We use 1-year forward Sales and EPS figures as we estimate the future growth of companies.

We have shifted focus to Core stocks (Large Cap, market leaders) that have strong future prospects which will provide better downside protection. However, one has to keep return expectations moderate as valuations are no longer cheap but in the fair value zone.

Divestment of Air India is pleasant news

DIPAM secretary informed that Tata & Sons has won the bid to acquire Air India. This is very positive news that the government is willing and able to divest stakes in public sector companies. This will open doors for more divestments which will fetch government funds for reducing debt and fund future growth. Every country that has done privatisation has gained tremendously in the short to medium term. We expect the same from India.

There can be the rub-off effect of Divestment on other PSU stocks as they become more efficient and improve governance.

Risks

Indian Economy

While Q1FY22 corporate earnings were a mixed bag there were a few upgrades, especially in the IT, Metals & cement sectors. Autos & Pharma were major disappointments. Real estate continued to witness strong up move. Normalization of economic activities continued through the month of September.

Currently, we are seeing an acceleration in demand around the festive season from i) pent-up demand, ii) increase in salaries of IT employees, iii) lower interest rate or discount offers on real estate and eCommerce.

Near-term risks can come from rising inflation. India still imports the bulk of its crude oil requirement and gas. Any rise in price will have to be passed on to the consumer. Other commodities like natural gas or coal have also spiked due to shortage issues across several countries. If this persists we may see risk to equity valuation.

However, if we keep aside the current valuation, we are optimistic about the Indian economy over the next 5 years. Even if we purchase shares at slightly higher prices, there is a good chance of earning healthy returns over the next 5 years. The Indian corporate sector is in the best position to gain pricing power and balance sheet strength. The majority of the sectors have seen consolidation. We are seeing this across sectors: Power, Telecom, Cement, Banks, NBFCs, Real Estate, building materials, Paper, pharma, capital goods, consumer durables, etc. This will give strong profitability for incumbents due to the high barrier to entry for the next few years.

Global Economy

There are signs of speculation in US primary and secondary markets and Cryptocurrencies. A lot of trading activity has led to an increase in leverage and higher trading volume. This is a risk to the market if not the economy. It may happen that the market comes off as the economy recovers as the benefit from fiscal stimulus will fade off. 

US interest rates are rising as investors start factoring in economic recovery and rise in short-term interest rates by central banks. We are also seeing the US market in correction mode at the index level it is falling below key levels. This can either lead to further correction or time-wise correction over the next few quarters. While such corrections with a backdrop of economic recovery are welcome as we get to buy stocks at lower prices. We despise corrections due to fear of recession but such interim correction with an improving economy is a good hunting ground for opportunities. That’s why they say, corrections are healthy. 

*There is always some risk but every risk doesn’t materialize. It is important to keep an eye on risks but it may not require an action every time.

Frequently Asked Questions

Aggressive Investor: “Few stocks are making big moves why are we investing cautiously or selectively?”

Today we are seeing run-up not-so-good quality stocks while quite a few Quality stocks are underperforming. Today’s fast-rising stocks are of inferior quality or very cyclical in nature. These are not great buys for the long term, at best trading plays. If you come across any stock tip or report, refer to our 10-Year X-Ray and you will notice that the color code of companies is either RED or mostly Red cells.

For long-term success we prefer caution over aggression, balanced versus bold, sustainable growth versus temporary.

Our process of fundamental analysis, and valuation-driven long-term investment management has served us well across market cycles. We do not move in and out sectors chasing price momentum nor do we believe that no price is too high for good merchandise. We have seen many cycles to believe that many of these tricks have good and bad years. We will also have our hits and misses but on aggregate, we try to deliver more consistent and higher returns versus other investment options.

“A principle is not a principle until it costs you something.” – William “Bill” Bernbach

On similar lines, “A process is not a process until it costs you something (or pinches you).”

Conservative Investor: “What if we are at the fag end of the bull market, time to sell?”

We have seen many recessions in past and saw stock market recoveries over a 2-3 year period. In the current scenario, we are past the recessionary period already, so any interim correction will be transitionary and may see a faster recovery versus the past.

Let’s take the worst period with the benefit of hindsight when Nifty peaked in Dec’07 and 3 years after that.

If we observe individual stocks, we can see that markets made high in Dec’07, went through correction of 50%, and recovered in Dec’10. During this period Nifty was flat but more than 40% of stocks earned positive returns. Out of 185 large and mid-cap stocks (BSE Group A), 78 were positive, and more than half earned >13% CAGR. Together these 78 stocks earned >17% CAGR.

Now, this was the worst-case scenario where the market had a stellar bull run in 4 years preceding 2007. Companies had added a lot of debt for expansion and valuations were expensive.

Today, we are past recession i.e. back to back GDP de-growth and most companies are in much better shape than in Dec’07 at low utilization, low debt, and upward trajectory in volume growth.

The above table shows that, if we can pick stocks carefully by avoiding ones that have run ahead of their growth and inferior quality, we increase our odds of making very good returns in a 3/5 year period.

If we do get interim correction, we can earn more as we get to add to stocks at cheaper valuations. On your own, you can set up an additional SIP during interim correction to improve returns. Odds are highly in favor of staying invested rather than exiting or delaying fresh addition as we can’t predict the right time to invest expect in hindsight.

If we look at past data, there was an 85% chance of beating FD return on 5 year period. If your time horizon is long-term (5 years+), the current valuation will matter less and 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.

This is the reason we recommend not to disturb the equity portion in your asset allocation. Changing your asset allocation will reduce long-term returns or missing out on the target corpus.

If you have decided to stay with 60% Equity and 40% debt, you can rebalance but do not deviate much from 60% in Equity. Use our Financial Planning tool to find your target corpus and required asset allocation/monthly saving.

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.

How to earn good returns from investments: