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Stay positive. Goldilocks period ahead for market and economy

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The festival season has started. Festivities bring with them hope. The drop in new Covid-19 infections and in the total number of cases brings hope. While the possibility of a Second Wave cannot be ruled out, a vaccine seems to be close and planning has started as to who will get it and when. The economy is normalising and places where people go such as markets, cinemas and religious establishments are opening up.

The second quarter earnings season is progressing well. While the economy is yet to get back to pre-Covid-19 levels, and we do expect second quarter GDP to show a 7-8 % contraction, yet Nifty companies are delivering earnings that are better than expectations. At this juncture it seems possible that Nifty EPS would be higher than the EPS delivered during same period last year in a significant manner vs expectations of a degrowth.

We started this result season with the expectation of a 5% degrowth in earnings. However, many large corporations have delivered better-than-expected numbers. Large profit pool IT companies and banks have done well, as have cement companies. Among the results announced so far, there have been very few disappointments.

The economy is bouncing back. We do expect third quarter GDP growth to be a flat on a year-on-year basis and if the festive season turns out stronger than expected, we could see a small growth as well.

The period ahead is when we hope to see ample global and domestic liquidity, declining interest rates, strengthening of domestic growth rate, a domestic policy environment that favours growth and low inflation.

Good rains and consecutive good crop seasons should result in lower food inflation. Food is a major component of Indian inflation. Lower capacity utilisation in the industrial space should keep manufactured goods inflation low. We are already seeing steps taken by the government to kickstart the ‘Make in India’ programme with a slew of incentives rolled out, including production- linked incentives in electronics and chemicals, higher duty protection in some cases, an outright ban on imports from China and Pakistan for power equipment, and a complete ban on imports, in some sectors like ACs (filled with gas). At the same time, the offshore competition will be kept at bay only for a limited time so that the domestic industry remains competitive. Lower corporate [email protected]% for existing units and 15% for new units, can help. At the same time, the monetary policy has been growth conducive with ample system liquidity and reduction in loan rates.

The global environment is conducive. India should benefit as the world diversifies its sourcing base. The Covid-19 issue is helping governments give strength to localisation.

Given the trends seen in second quarter earnings, we do expect Q3 and Q4 results to be stronger. While margins seen in Q2 are the result of a high focus on costs, we do expect some of the cost cuts to sustain longer. While valuations are not cheap, we do expect the profit momentum, favourable liquidity and better policy environment to help sustain the market at current levels.

The MSCI has increased India weightage and this should result in passive flows of the order of $2-3 billion in a part of the year when the usual flows are slack.

As the economy comes back to normal, the fear of NPA is receding. We do not expect India to have another round of a stringent country wide lockdown. Hence, the uptick in economic activity should continue. Good liquidity and low interest rates can benefit NBFCs and NBFC-like banks. While the market is close to all-time high, financials are still significantly lower and could do well in this scenario.

(The author is Business Head & CIO of ASK Investment Managers. The views are own.)

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