Trading Places

Foreign portfolio investors (FPIs) dominated the stock market in 2020/21, saving the day for equities even in the face of the deadly pandemic. However, they have turned cautious post Covid 2.0. In April alone, FPIs exited positions worth over Rs 9,600 crore, snapping their net buying spree for six months in a row during which they had pumped in close to Rs 2 lakh crore.

FPIs invested a total of Rs 2,74,034 crore in equities in FY21, while domestic institutions, particularly mutual funds, sold a net Rs 1,20,732 crore. FPIs have made India the top investment destination among emerging markets. Even high networth individuals (HNIs) and the new breed retail investors have proved to be very smart buyers in FY21.

Risky Bet?

The second wave of Covid-19 has increased the risk perception in the equity market compared to last year. "There is a reversal of India's perception in the international media, from a country that managed Covid-19 very well and supplier of vaccines to the world, to a country that has failed to provide essential health support to its citizens," says Srinivas Rao Ravuri, Chief Investment Officer, Equities, PGIM India Mutual Fund.

Acute pressure on the health system has led to over a dozen state governments imposing restrictions on non-essential activities to break the chain of the virus, hampering production, and thereby leading to job and income losses for individuals and output and revenue losses for companies. Reflecting the trend, the Index of Industrial Production slumped 3.6 per cent year-on-year in February.

However, the economic loss this year is expected to be lesser compared to last year, with lockdowns being sporadic and region-specific, and imposed only for a few weeks. "In recent weeks it (economic activity) is estimated to have dropped 15-20 per cent compared to the pre-Covid level. There was a fairly robust recovery underway prior to the second wave," says Gaurav Misra, Co-head, Equity, Mirae Asset Investment Managers India.

Pandemic Impact

Based on the severity of the second wave of Covid-19, several agencies have downgraded the growth forecast for the country - The economic research wing of State Bank of India slashed it to 10.4 per cent from 11 per cent, while India Ratings brought it down to 10.1 per cent from 10.4 per cent.

US-based rating agency S&P Global Ratings, which projected India's growth rate at 11 per cent earlier, had slashed it to 8.2-9.8 per cent for FY22, based on two scenarios - severe and moderate. Meanwhile, Moody's also slashed India's GDP forecast for FY22 to 9.3 per cent from 13.7 per cent earlier.

"If Covid-19 is handled appropriately, the broad growth trajectory will remain unchanged, with some cut in the growth rate. Beyond that, the magnitude of its impact on corporate earnings will set a firmer direction for the market," says Misra of Mirae.

Last year, when Covid-19 started spreading globally around mid-February, the Indian market started easing. In March, for the first time in 30 years, the 10 per cent circuit breaker was triggered twice in a single month -on March 13 and March 23 - when trading was stopped for 60 minutes. However, after that the equity market recovered gradually and the benchmark indices - the BSE Sensex and the NSE Nifty - went on to touch record highs in following months, creating the steepest V-shaped recovery ever.

The growing disconnect between the economy and equities was another impact of the pandemic that the Indian market saw in 2020. The volatility index (VIX), which in common parlance indicates the fear (when at higher level) and confidence (at lower level) of investors in the market, hit an unprecedented high of 86.63 on March 24, 2020 and stayed above 70 till month-end, and only by August it could return to the previous five-year norm of below 20 points, albeit with a few exceptions.

Though similar trends were witnessed globally in 2020, the situation seems to be different in India vis-a-vis other countries, including emerging markets, currently, given the second wave of the pandemic that swept the country and the government's feeble response to it.

In contrast, since March 2021, we have not seen too many wild fluctuations in indices or the market. Even volatility remained below the normal over the one-month period ended May 7, 2021 - it had inched above 20 only on May 11. However, the growing disconnect between the economy and the stock market, which was flagged as a concern during the first wave of the pandemic, still remains.

Investment Trends

Covid-19 has brought some unexpected changes in market composition, particularly in terms of stature and influence of its dramatis personae, compared to pre-pandemic levels. Individuals are garnering a higher slice of the trading cake, compared to registered entities, including mutual funds.

The share of individuals and proprietary trading have gone up by 6.6 per cent and 1.7 per cent, respectively, compared to pre-pandemic levels on the NSE cash segment, according to a study based on the average turnover, correspondingly bringing down the share of registered firms, including institutional investors, corporate and partnership firms, by 8.3 per cent in the 12 months to January 2021. The share of mutual funds, too, eased from around 7.5 per cent to 5 per cent.

During the 10 months ended January 2021, the two depositories together added over one crore new investor accounts, taking the total to over 5 crore. The journey from 3 crore to 4 crore had taken over 28 months. In the year ended February 2021, depositories added about 131 lakh accounts, according to data from the Securities and Exchange Board of India (Sebi) .

Millions of retail investors are thronging the market, taking advantage of online trading platforms. Nikhil Kamath, Co-Founder and CIO True Beacon and Zerodha, India's leading online trading platform, says, "The platforms themselves cannot be attributed to be the sole reason for the bull run, but the fact that the pandemic has provided people with more time to evaluate their investments and participate." The trend has been in line with a global phenomenon, but sensing the opportunity, several Indian brokerages have initiated campaigns to attract first time investors into their fold.

"Over the last five years, retail turnover has doubled in the stock market; the combined share of FPIs and domestic institutional investors (DIIs) has declined to 18 per cent of the total volume," says Ravuri of PGIM. "FIIs own about 25 per cent of BSE 200 companies, whereas DIIs own about 13 per cent. So, the trend in FII activity will continue to impact market movements," he adds.

SIP inflows are coming down with most retail investors shifting to trading on their own or investing in other asset classes. From about Rs 6,000 crore of systematic investment plan (SIP) inflows in April-May 2020, it has declined below Rs 3,000 crore by January 2021. This trend has affected the assets under management (AUM) of mostly equity and growth mutual fund schemes.

There is also a growing trend among Indian investors to diversify their portfolios by investing abroad. Dedicated overseas mutual fund schemes garnered inflows of around Rs 5,000 crore in just two months - December 2020 and January 2021 - according to Sebi data.

Driving Influences

Investors generally analyse factors pertaining to their target equities while playing in the market, including valuations, liquidity, general business environment and economic growth prospects. FPIs also look for political and social stability in the country they choose to invest, besides seeking markets that offer high returns.

The Indian market has always commanded premium valuation compared to its emerging peers, historically. The country had outperformed markets such as Germany, Japan, France, Russia, the UK and China, but lags South Korea and Taiwan, in FY21, according to the India Strategy report released by Motilal Oswal Financial Services (MOFS) in April.

So, what makes India so attractive among emerging markets? "There are a number of factors like the promising structural growth story for the next one-two decades and diversified representation in the indices, including attractive sectors like technology, healthcare and consumption," says Ravuri of PGIM.

Liquidity in the economy is the lifeblood of a thriving market. Due to the severe impact of pandemic-driven lockdowns and job losses, some funds are being taken out of investible resources - from equities directly or from mutual funds - for meeting exigencies.

Also, the Reserve Bank of India (RBI) is ensuring that liquidity in the economy is not constrained at all costs. The central bank has announced measures to ensure the same, including acquisition of government securities (G-secs) to the tune of Rs 1 lakh crore during the April-June 2021 quarter.

However, the scheduled higher government borrowing programme for FY22 could hamper credit flow in the economy. Though the government claims it will borrow Rs 12.05 lakh crore from the market in FY22, lower than the Rs 12.80 lakh crore estimated for FY21, this figure is 64 per cent higher than the initially budgeted target of Rs 7.8 lakh crore, before the advent of Covid-19.

Though inflationary pressures are building up, normal monsoon forecast for the year and consequent rise in production are giving comfort to investors. Markets are jittery about rising inflation since it could force RBI to raise policy rates, resulting in higher credit cost.

Recent moves like the US Federal Reserve refraining from hiking rates and announcement of $1.8-trillion stimulus have resulted in a stronger rupee. FPIs favour a stable rupee as it enhances the value of their investments in India in dollar terms. However, steeply rising global commodity prices could make India vulnerable to both inflationary pressures and currency depreciation. The rising inflation in the US has the potential to nudge the Fed to hike policy rates anytime now, which could affect FPI inflows.

On the domestic front, "Covid cases, progress in vaccination, commodity price inflation, corporate earnings growth are key factors expected to decide market direction in FY22," says Gautam Duggad, Head, Institutional Research, Motilal Oswal Financial Services, adding, markets have been fairly resilient hoping that Covid 2.0 is only a short-term phenomenon.

The market is already at peak valuation if one has to go by the latest price-earnings (P/E) ratio. According to an analysis by MOFS, Nifty 12-month forward P/E of 20.7 is now at a premium of 18 per cent against its long-term average (LTA) of 17.6x, while the Nifty 12-month trailing P/E of 27.4x is 45 per cent higher than its LTA.

The most reliable parameter from the long-term investor perspective is 'trailing P/E', when the pandemic is causing disruption. "Retail investors should take a long-term view and should invest systematically in diversified equity funds and should not try to time the market. Having a long-term approach to investing in equities is super critical and investing through bull and bear periods will give investors the advantage of decent average pricing," says Duggad of MOSF.

Referring to the explosion in retail investor base, Ravuri says, "Typically retail participation is a function of markets; in good markets they become very active as money making looks very easy. But when the market turns, investors, especially those who trade, incur losses and exit."

Looking Ahead

Despite the general consensus that Indian equities could survive any short-term impact of the pandemic on expectations that inoculation would be expedited and health infrastructure would be fixed on a war footing, the current pace of preparedness and activity does not inspire that confidence among investors.

"We expect range-bound markets depending on how the Covid situation unfolds and vaccinations picks up pace. The pace of earnings will broadly decide the market trajectory for FY22 as expectations of recovery are quite high," says Duggad of MOFS.

Ultimately, the longevity of the impact of Covid-19 will decide the direction of the market in FY22. The pace of vaccination is a key concern since supply side bottlenecks still remain a hindrance. The April-June 2021 result season will also throw some light on the road ahead for the Indian market.

(BS Srinivasalu Reddy is a Mumbai-based journalist)