2021 will be a year of managing risks of soaring equity valuations – Mint

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After a good start in the new year, with the Nifty 50 index closing over 14,000 levels for the first time, all eyes are on whether the global and Indian markets will continue its winning streak in 2021.

The market clocked positive gains for five consecutive calendar years till December 2020. This despite the fact that the pandemic tested investors nerves. Even so, 2020 ended-on with 15% gains in the Nifty 50.

Historically markets have seen six consecutive years of positive gains in the Nifty too. This should comfort investors that 2021 could end positively as well. To top it, 2021 is expected to be a year of recovery in economic as the pandemic lockdown impacted economic growth rates.

“We expect CY21/FY22 to be a better year with likely strong recovery in both the economic and earnings. There will be a remarkable shift in nominal GDP growth from -6.1% in FY21 (estimates) to 14% in FY22 (estimates), which will help corporates to report healthy revenue and earnings growth,” said Jaideep Hansraj, MD and CEO, Kotak Securities.

The only worry is whether the high valuations will persist in 2021. Note, the Nifty 50’s one-year forward earnings are high at about 22- 23 times FY22 earnings. But so far liquidity conditions are good, and demand for stocks with domestic investors remain high. However, markets are rising on low volumes, which is seen as a sign of worry.

No doubt, the upcoming earnings season will provide cues on market direction in the coming quarters. TCS is expected to kick-start the earnings season, which is likely to start on a firm footing, on Friday. Besides, this week’s Markit Manufacturing PMI and Services PMI are expected during the week, which will verify whether the recovery is indeed strong.

2020 has been a remarkable year for some sectors. After years of dwindling investor returns, the pharma sector clocked a sharp increase in returns as pandemic drove people to higher drug sales. Little surprise, indeed, that IT and pharma stocks stood out.

The IT sector also showed resilience as businesses ramped up quickly post the lockdown. Deal wins have been good in a pandemic year as digitalisation drives large global corporates to increasingly spend on technology.

But for companies like Larsen & Toubro Ltd its technology subsidiaries such as L&T Infotech Ltd seemed to have provided the lift.

Some alternative assets such as Bitcoin’s have had a sharp run-up too on abundant global liquidity. But things here have to be seen with a little more circumspection.

For some sectors, such as commercial, there are high expectations built around commercial good vehicle sales.

In the paints segment, there has been a sharp rise in valuations of these companies.

Of course, this shows how valuations can get lifted with large foreign and domestic fund inflows into stocks. Having said that, liquidity inflows have to persist at higher levels for stocks to hold on to their valuations. But investors may also see nerves tested on high volatile days as knee-jerk reactions could become a feature in 2021.

That said, navigating the market valuations for sectors and stocks that are relatively undervalued could be difficult in 2021. Stock prices are quite pricey for some of the frontline discretionary names. Earnings in FY22 are already priced at 23 times, which is high historically.

On the other hand, debt yields have dwindled to their lowest levels of about 5-7%, which means small conservative investors will find fixed income investing quite unattractive. But should investors put more of their nest eggs in the equity basket in 2021?

Both large- and small-caps are all quite stiffly priced, investors will have to have the nerve to stomach high risks. But being on the fence could also mean losing on potential equity returns, while debt investments lacklustre. 2021, from this perspective, will be investors biggest testing year as they have to manage greed and risk appetite like never before.

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