Runaway equity rally rerun unlikely this year

Having said that, investors will have to tone down their expectations in 2022. Expecting a repeat of 2021 is foolhardy given the high valuations. Besides, downside risks have risen in the past few months. First, in 2022, equity investors need to brace for a scenario of interest rate hikes and global central banks’ winding down of the surplus liquidity.

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Recall that to combat covid-19 led global economic slowdown, central banks worldwide slashed interest rates to record lows. They also pumped liquidity in the form of stimulus. The combination helped equities climb despite the pandemic. But a serious side effect of the ultra-accommodative policies is being felt now with inflation rising.

So, with the US Federal Reserve hinting at three rate hikes and wrapping up its bond purchases programme by March, global equity markets are in for a bumpy ride. Some emerging economies, including Brazil and China, have raised key lending rates. Among developed nations, the Bank of England raised interest rates in December. In contrast, the Reserve Bank of India retained lending rates at its final meeting of 2021.

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What’s more, corporate earnings may disappoint given the pressure on operating profit margins and the lack of pricing power in some sectors to pass on the burden of cost inflation. Expectations are high, though. “Consensus earnings per share estimate for Nifty for FY23 is at ₹900, which works out to 27-28% three-year CAGR growth—this is something unseen. It remains to be seen how corporate earnings actually pan out, so elevated earnings growth expectations remain a risk for the equity market,” Sahil Kapoor, head of products and market strategist, DSP Investment Managers, said. CAGR is compounded annual growth rate.

India is not alone here. Earnings estimates for US stocks are on the higher side. According to Lance Roberts, chief portfolio strategist, RIA Advisors, a disappointment in earnings is likely. “But, as is always the case in a bull market, analysts are exceedingly optimistic in their estimates. Analysts increased their earnings estimates despite the Fed tightening monetary policy, potentially weaker economic growth, less liquidity, and tougher annual comparisons,” he said in his blog dated 25 December. He said that analysts’ estimates for the US index S&P500 currently exceed the historical 6% exponential growth trend.

Be that as it may, it is paramount that corporate earnings show a robust growth to justify Indian stocks’ stretched valuations. “We feel the valuations of Indian equities at around 21 times on a one-year forward earnings basis, are two standard deviations above the mean, and so are expensive. Valuations are likely to correct if corporate earnings in FY23 were to disappoint,” said Naveen Kulkarni, chief investment officer, Axis Securities Ltd.

Meanwhile, cases of the Omicron variant of coronavirus are rising—a factor responsible for the recent correction in stocks. If Omicron becomes a severe health threat, investors cannot ignore the risks of restrictions or lockdowns. All said, at the onset, 2022 appears fraught with challenges for Indian stocks, including firm crude oil prices, uncertainty on commodity prices and a looming threat of a potential third covid wave.