Recovery or correction: Here are key things for the markets to watch out for in 2021

2020 was one of the most chaotic years as well as a volatile year for the equity markets. The first two months saw indices hitting all-time highs which later sharply fell to multi-year lows as soon as the pandemic struck. The Indian markets have recovered around 80 percent since March lows and continue to trade at all-time highs.

The recovery has been mainly on the back of excessive liquidity being pumped by global central banks, continued FII inflows, better than expected earnings revival and some rebound in the macros.

So how is 2021 expected to be? Will it witness some consolidation or correction from record-high levels or continue to rise higher?

Experts feel that the premium valuations of the market are likely to sustain as long as the earnings visibility will sustain. Also, given the low-interest rate scenario, equities will continue to remain attractive investment options for investors.

Reliance Securities in a recent note stated that premium valuation will sustain, going forward on the back of recent inclusion of stocks in the Nifty (Shree Cement, SBI Life, HDFC Life and Divi's Labs) having high PE multiple compared to the replaced stocks i.e. Vedanta, Zee Entertainment, Bharti Infratel and Yes Bank. Also, better prospects of earnings revival and the low-interest rate will add to the bullish sentiment, it added.

The brokerage has given a target of 14,900 for the benchmark Nifty50 for 2021 end.

So what will drive the rally or become headwind? Here are the key things to watch out for in 2021:

Strong co-relation is seen between Foreign Portfolio Investors(FPI) inflows and index return is quite visible. Reliance Securities noted that data of the last 19 years show that FPIs’ investments in domestic Indian equities were negative only in three years, wherein the Nifty delivered negative return in two years and recorded muted return in one year.

Given the current scenario of tepid return from fixed incomes globally and continued soft monetary policy by the global central bankers, the FPI investments may continue to drive Indian equities in 2021 as well, it said. Better return prospects, government reforms, and a weak dollar will continue to attract FPI inflows into Indian equities, it added.

Companies witnessed a sharp earnings up-tick in the September quarter which surprised the investors. Additionally, the commentaries of most management were quite upbeat, as if the catastrophic impacts of the pandemic are behind. As per Reliance Securities, going forward, the Nifty earnings are expected to register a growth of 39 percent for FY22E and 20 percent for FY23E which should be supported by a low base, lower tax rates, low-interest costs and revival in demand scenario with the complete opening of business activities post-vaccination rollout. It also noted that over 30 percent growth last time was seen in FY10 immediately after the GFC, mainly on account of stimulus provided by the government through a reduction in excise duty and service taxes.

The government launched the Performance Linked Incentives (PLI) scheme in the current fiscal, which will also play a vital role in achieving size and scale in the manufacturing segment. As the PLI scheme is based on incremental production, the companies will try to ramp-up production to maximise their returns, which essentially bodes well in terms of incremental revenue for the government and meaningful pick-up in economic activities, noted Reliance Securities. The total budgetary outlay for this scheme is pegged at Rs 1.97 lakh crore. On average, 5 percent of production value is provided as an incentive, with which the minimum production due to the PLI scheme is estimated at Rs 39 lakh crore in five years.

The government has provided a huge economic stimulus to revive and support the economy during the peak of the COVID-19 pandemic. The government and the RBI announced a series of fiscal and liquidity support to the tune of Rs 29.9 lakh crore between March 2020 and October 2020, which is 14.6 percent of GDP. The stimulus provided by the government is bigger than the one provided during the GFC.

"Notably, a major chunk of this unprecedented stimulus support is aimed to revive the MSMEs, industries and agriculture, which were badly hit due to COVID-led lockdowns. Therefore, the positive impacts of this should continue to be felt in subsequent months as well," Reliance Securities explained.

This may be one of the headwinds for the markets going to 2021. India’s fiscal deficit is likely to surge to 6.1 percent or Rs 12.25 lakh crore in FY21E, which would be the steepest deterioration in the last 10 years. However, the brokerage noted that historical evidence suggests that such deterioration has not hampered governments’ capital spending. The government’s capital expenditures clocked 14 percent and 12 percent CAGR in the first three and five years, respectively after the GFC from FY10, when fiscal deficit peaked at 6.4 percent, it added.

Most of the large caps are trading at peak multiples or at higher than their last 5-year averages while many of the broader market stocks are still trading at reasonable valuations. There are signs of markets broadening out as reflected in the fact that heavyweights have taken a pause in the last couple of months while broader market stocks have also started performing. It seems valuation catch-up is happening in the markets. Investors seem to be looking for stocks that are at low PE multiple and have not participated in the rally so far.