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Poonam Tandon
Chief Investment Officer

Market Matters August 2020

Equity market indices continued their advance largely driven by strong global cues, optimism surrounding earlier than expected economic recovery and the progress in COVID-19 vaccine trials. Fixed income markets reacted to the higher inflation number and minutes of the RBI MPC meeting.

Globally, the equity market rally was driven by better than expected corporate earnings and positive news flow surrounding vaccine trials. On US macroeconomic data front, there was a sequential improvement. US Fed affirmed its accommodative monetary policy stance but altered its policy framework to average inflation targeting. US dollar weakened whereas commodity prices remained range bound. Domestically, government continued with the phased opening of the economy. There was a flare up in geo-political tensions due to skirmishes on the Indo-China border. With respect to domestic macro-economic data, Q1FY21 GDP print came sharply lower. However, other key economic data viz., industrial production, core sector data & manufacturing PMI displayed sequential improvement. Rainfall activity remained strong driving overall sowing activity.

Over the past few years, the equity market rally had been led by multiple expansion without accompanying earnings growth. This was on the back of huge surge in liquidity following global stimulus. Based on historical data (for domestic markets), PE ratios above 21x have always been considered as expensive and the markets had been hovering in that zone for past 3-4 years. COVID-19 triggered a correction which lead to a mean reversion of market valuations. Historically, such a tectonic shift has caused a rotation of sector leadership. Thus, new sectors could emerge as market leaders. On the fixed income side, domestic markets witnessed huge FPI outflows since March 2020 due to heightened fears of coronavirus induced global recession. Aggressive fiscal and monetary measures to alleviate the impact of lockdown & to lower borrowing costs had helped ease bond yields aided by surplus systemic liquidity. However, high and sticky CPI inflation (above MPC’s tolerance threshold at 6%) for past two quarters lead to a pause in the policy rate action.

In the near term, markets would keenly look for signs of economic normalisation, further developments in corona virus vaccine trials, evolving geo politics, monsoon progress and further fiscal / monetary stimulus. In the medium term, impact of the recent extraordinary policy response, approaching US elections, commodity price movement, trade war and corporate earnings trajectory / shock would also be monitored.

Considering the looming risks and the uncertain economic growth trajectory in the near term, equity market correction cannot be ruled out from current levels. Market volatility could rise but it can also provide attractive opportunities to accumulate quality stocks. Bond yields could remain in a volatile range in the near term due to interplay of factors such as inflation, fiscal deficit, government borrowing balanced by likely surplus systemic liquidity due to RBI’s continued easing measures.



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