Is the market pricing in the possibility of a third wave of Covid
Is the market pricing in the possibility of a third wave of Covid

Is the market pricing in the possibility of a third wave of Covid

Over the course of the first and the second wave of the pandemic, the market proved to be very resilient. But now, as we remain poised between the second wave of the pandemic and a possible third wave, speculations are rife about whether or not the market is reflecting this possibility. Is the market factoring in the third wave, and what it could bring with it?

The equity markets have largely looked through the turbulent period of April/May’21 and have shown strong resilience, with indices touching all-time highs recently.

Equity market has been strong and largely looked through the second COVID wave on the back of best-in-decade earnings delivery in FY21, strong liquidity and robust participation from non-institutional investors. Sentiments are also buoyed by the expectation of an even better FY22.

Corporate commentary has turned positive once again from Jun’21. Quarter-end updates from several corporates indicate a healthy revival in Jun’21 after a subdued April and May, while several high-frequency macro indicators have also recovered. After FY21 ended with a solid 15% EPS growth for Nifty (best since FY11), we expect FY22 to commence with a bang and expect a further build-up over the remainder of FY22. 1QFY22 earnings are estimated to be strong despite the restrictions imposed, albeit benefitting from the deflated base of 1QFY21.

The key drivers are: a) Metals – strong pricing environment and higher exports to offset decline in domestic volumes; b) IT – the strong performance would continue as we expect median USD organic growth of 3.3% CC QoQ in 1QFY22 on the back of a strong demand environment and healthy YoY margin expansion; c) BFSI – despite muted asset growth, lower provisioning costs would drive strong earnings YoY; and d) Consumer – expected to post a healthy performance with 23–25% EBITDA/PAT growth, despite rising commodity cost pressure.

Another fact remains that while the second wave caught the country off-guard, the third wave - although still largely a mystery - is nevertheless something that is part of the talk. So, it is not entirely unknown, in the way the second wave was. So, it’s unlikely that the market is not pricing in the existing information.

Also, in the 2017-2018 period, mid and small cap stocks saw great performances - just like we’re witnessing now - only to fall flat later. But the difference this time around appears to be that both traders and investors are more focused on the quality of the stocks they buy or sell. That could make all the difference. 

The primary markets are also seeing a flurry of activity with several IPOs lined up. Amid this positive setup, rising commodity costs, higher inflation prints, and a potential rate increase are key headwinds.

Equity markets have seen a sharp run-up in the last 12-18 months bolstered by healthy earnings, improved sentiments, benign liquidity, and low cost of capital. Current valuations, while not expensive, are not lucrative from a risk-reward perspective. Meanwhile, balance sheets and cash flows have improved in FY21 as corporates tightened costs and deleveraged. The gradual unlocking of the economy and an improved demand backdrop do offer bottom-up opportunities. Consistent earnings delivery v/s expectations is critical for further outperformance.

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