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Friday, January 28, 2022

Explained: Covid-19 cases are rising, and so are the markets. What’s going on?

🔴 Equity investments have started the year strongly in spite of concerns over the Omicron spike. How much has the market gained, and why is it rising? What risks lie ahead? Will the rally continue?

Written by George Mathew , Sandeep Singh | Mumbai |
Updated: January 14, 2022 7:02:35 am
Over the nine trading sessions this calendar, the index has risen by 2,982 points or 5.1. (Express Photo: Ganesh Shirsekar)

Equity investments have started the year strongly in spite of concerns over the Omicron spike that has once again led to restrictions on mobility, hit contact-intensive services, and threatened to slow the pace of economic recovery.

The third wave, which saw nearly 2.5 lakh infections in the country on Wednesday, has coincided with the decision of the US Federal Reserve to hasten the withdrawal of the stimulus, and indications that interest rates may increase sooner than expected. But these factors, along with rising domestic retail inflation, have not deterred Indian stock markets.

How much has the market gained?

The benchmark Sensex at the BSE moved in a narrow range in the last month of the last calendar, and closed at 58,253 on December 31. Over the nine trading sessions this calendar, the index has risen by 2,982 points or 5.1% — on Thursday, it closed at its highest level since October 26, 2021. Thursday’s close (61,235) is only 530 points or 0.85% short of the highest ever closing of 61,765, seen on October 18, 2021. Although the services sector, including travel, tourism, and hospitality have been hit by the Omicron wave and demand is expected to come under pressure in many other sectors including FMCG, the market remains buoyant.

Why are the markets rising?

The markets have risen as the selling pressure from foreign portfolio investors (FPIs) has eased and buyers have come into the picture, and domestic inflows into equities have continued.

FPIs, who sold stocks worth a net of Rs 38,521 crore in the stock markets between October and December 2021, have invested a net of Rs 3,227 crore in January so far.

On the other hand, domestic institutional investors, who invested Rs 31,231 crore in December, have invested a net of Rs 5,485 crore in January so far.

Retail investors and mutual funds have been in buying mode, with the latter getting investors’ money amounting to Rs 25,000 crore in December.

The market has already factored in the Fed’s tightening plan, and is hopeful that the Reserve Bank of India will continue its accommodative monetary policy in response to the need for supporting the economy.

While Omicron remains a threat and cases continue to rise across the country, market participants believe that the less virulent variant is not challenging the health infrastructure as of now, and is not expected to majorly hurt the economy.

Is this how the markets behaved during the Delta surge too?

In the period between March 10 and May 6, 2021, when active cases in India rose from around 20,000 to over 4.1 lakh, the Sensex fell 5.9% from 51,279 (March 10) to 48,253 (May 4). However, as the cases declined over the next one month, the Sensex recovered quickly to hit a new high of over 52,000 in June. Over the next few months, it rose further and hit its all-time high of over 62,000 in October.

What risks lie ahead?

If the Fed tightens too fast, FPI outflows could follow, impacting the domestic market and the rupee. Investors are also waiting for third quarter earnings reports from the corporate sector. A possible increase in hospitalisations and deaths over the next couple of weeks may hurt sentiment and impact the economic recovery. The markets are also waiting keenly for the Union Budget in February, and the RBI policy for clues.

“Having realised that even their (FPIs’) relentless selling has not brought the markets down, as perhaps they expected, the FPIs are now on the back foot. Seizing the opportunity, exuberant retail investors assisted by the DIIs flush with funds are driving the markets up, said V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services.

According to Vijayakumar, there is both a positive and a negative dimension to this rally. “The positive is that high-quality large-caps are leading the rally. The negative is that many low-grade stocks that do not justify any investment are also going up,” he said.

Will the rally continue?

Even as the markets rise, concerns around valuations remain, and to that extent, if the earnings growth is not strong, the rally could hit a bottleneck.

A report by UBS economist Tanvi Gupta Jain raised this concern. “Despite our expectations of double-digit earnings growth in FY23E/FY24E, we think equity upside is capped by expensive valuations,” it said.

While FPI flows fuelled the rally over the last 18 months, they may not support the equity markets in the same way going forward because of Fed’s decisions to withdraw the stimulus and raise interest rates.

Another constraint to the rally may come from a faster than expected switch to policy normalisation as inflation remains at elevated levels. There is a possibility that even RBI could hike interest rates in the second half of this calendar.

On the other hand, support for equities could come from a government-led infrastructure push and investments, higher FDI in manufacturing, and a production-linked incentive boost to manufacturing.

Investors must temper their expectations from the equity markets, experts say. However, they feel equities may continue to outperform other asset classes this year too — so, investors who are underweight on equities should continue to invest in them.

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