Why Stock Investors Shouldn’t Worry About an Expensive Valuation

In an incredible resurgence from March lows, the stock market has broken past its all-time high. Despite the uncertainty on many economic fronts, we believe the worst is over for the stock market.

While some still fear a lethal second wave of the Covid pandemic, the market has prudently focused on the bright spots: the downward curve of general Covid cases, a largely unaffected rural India, and urban cases restricted to a few metropolitan areas. Also, the feedback from Moderna and Pfizer, the leaders in the vaccine race, are very encouraging. Mobility indicators in recent months point to a rapid recovery at stake.

Coming to the economy, all of the high-frequency indicators are in positive territory. The consensus opinion considers that the rural and agricultural economies are doing very well. The Economist Intelligent Unit believes that the economies of India and South Korea will be the first to recover from the Covid pandemic. We would not be surprised to see a nominal GDP growth rate of more than 15% in Fiscal Year 22, based on the low base of Fiscal Year 21. Corporate earnings for the second quarter of Fiscal Year 21 were solid, given a decline 10% in revenue from pre-Covid levels, which is notable given the magnitude of the pandemic. Following his lead, the third trimester is also likely to be a healthy holiday trimester.

Having marked the income statement, let’s move on to the balance sheet. According to Crisil estimates, 99 percent of the more than 3,500 large companies that have a credit exposure of Rs 250 crore or more are unlikely to opt for RBI’s one-time debt restructuring. We agree, given that India Inc’s interest coverage ratios were comfortable even in the worst Covid quarter of the first quarter of fiscal 21. Furthermore, most companies have strengthened their balance sheets by propping up capital in record numbers, exceeding the levels of previous years. More importantly, the Indian banking system is much stronger, having credibly increased its recovery efficiency, as revealed by our recent checks with collection agents.

Don’t fight the Fed, they say! Not surprisingly, we are witnessing a massive injection of liquidity globally. Central bankers are pumping money at a mind-boggling rate of over a billion dollars an hour. Interest rates have been lowered, with a solemn promise to keep them moderate for as long as necessary. With the US dollar on a sideways or declining trajectory, capital is sure to flow into emerging markets. Even at home, the RBI has materially lowered the yield curve through cuts in the buyback rate and open market operations. Mortgage loan rates, for example, may never have been as low as they are today. Top-rated companies are borrowing at 7 percent in stark contrast to the double digits, which reigned only a few years ago. In addition to the actively managed funds, Indian equities would also receive a passive cash flow, following the MSCI replenishment in their favor.

The market structure looks very promising after a long period of consolidation since 2018, and volatility is also receding from its high levels. Valuations do not appear to us to be in dangerous territory, unlike what is widely perceived. Optically, the values ​​may appear high, but not when viewed in the context of where the cost of capital is and also the lack of opportunities in other asset classes. As earnings catch up, even in two of the next four years, the same naysayers will declare the valuations reasonable.

On the other hand, concerns about the fiscal deficit cannot be ignored. The sustainability of small businesses, jobs and the like are in question. That said, no market rally expects all ticks to be marked in your favor. The market gains traction from a number of factors that provide credible support: a benign crude and raw materials environment that would benefit equities, a government-backed manufacturing mega boost in India, reduced taxes, and global players seeking aggressively an alternative to China. The Indian government has reportedly set aside incentives amounting to more than $ 20 billion to attract global players to manufacture in India.

In general, we believe that the market will get ahead and anticipate the subsequent economic recovery. If 2020 was largely about survival, both in terms of health and finances, it was also the most opportune time to adjust and adjust portfolios. 2021, in all probability, would reflect the year 2003 from a market point of view. In our view, the best for the markets is immediately ahead. It’s time to be all ears to hear the joy of the new year!

(The author is YES Securities Senior President and Institutional Research Director. Opinions are his)