Investors are buying select companies despite rich valuations; here’s why

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Markets this week steadily corrected, especially the index heavyweights as FPIs maintained their profit booking stance. While stocks continued to march forward, the global economy underwent radical changes ever since the pandemic hit shores. Investors, who had become conservative back in 2020, have now become more open to increasing their risk appetite.

Globally, central banks came to the forefront as they borrowed heavily in lieu of reviving the economy from the slump. With a rising fiscal deficit, India’s debt book saw a sharp 1,090 bps jump to 58.8% of GDP by March’21 from 47.9% in FY19. Triggered by the pandemic, sector leaders such as consumer durables and autos fell out of favour as they handed the baton to pharma, technology, infrastructure and construction sectors. Corporates took a cautious approach as they shifted focus from chasing aggressive growth and expansion towards cleaning their balance sheets to cushion the impact of any future uncertainties. In fact, based on research of 1,000 public firms, debt reduction across these companies came in at about Rs. 1.7 lakh crore in FY21, which is one-fifth of FY20 levels.

While FY21 may seem like the year of deleveraging, it turns out to be a year when corporates switch from expensive debt to cheap debt as they resorted to borrowing funds at lower rates by issuing bonds to repay their high finance costs – A smart tactic to benefit of the lower yields! Companies have prioritised better management and cost control measures which turn operating leverage in their favour. Deferring non-critical capex and curbing excess spending to stabilise and grow cash flows has become the norm. Such prudent management of capital has been well received by investors, who rewarded these companies with rich valuations, despite some macro-related uncertainties looming over their head. Hence, a simple strategy for investors will be to continue to let their longs in strong players ride while those seeking new positions can enter on pullbacks.

Event of the week

Finance Minister Nirmala Sitharaman announced Rs. 1.5 lakh crore of additional credit for small businesses, more funds for the healthcare sector and loans to tourism agencies and guides in an attempt to accelerate liquidity to the most concerning sectors of the economy. These initiatives aim to cushion the foundation of the economy both from the demand and supply side. Without a doubt, these measures are a step in the right direction, but the gloomy economy connoted by the core sector data screams for something more significant. India’s core sectors registered a 16% YoY jump in May, which is much lower than the 61% YoY rise we saw in April. As the core data points to a slowdown in recovery, the Indian economy may demand additional support from the government to recover swiftly.

Technical outlook

Nifty50 index closed negative and remained in red throughout the week, but still, it has gone nowhere. In fact, the index is finding strong demand around 15600 levels and trading in line with other emerging market indices. As long as we are trading above the current support which seems a more likely scenario, traders are advised to maintain a cautiously bullish bias and can initiate long positions around the support while keeping a stoploss just below 15560 levels. The immediate resistance is now placed at 15,900.

Expectations for week ahead

Large and midcap IT companies will remain in focus the next week as Q1 FY22 result season commences in India. USA’s IT services companies registered exemplary earnings performance with upward revision in their outlook propelled by strong tailwinds. Hence, in a similar fashion, IT stocks in India have been witnessing a strong push over healthy earnings expectations. Investors are therefore advised to look for any short pullbacks post earnings as an opportunity to enter the IT sector. Nifty50 closed the week at 15722.2, down by 0.87%.

(The writer is head of equity research, Samco Securities. Views expressed are personal)