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While retaining his bullish view on the Indian equity market, Christopher Wood, global head of equity strategy, Jefferies believes that Indian equity markets are likely to underperform in case of a global risk-off triggered by a taper scare. However, he continues to remain structurally bullish on the domestic markets and has hiked allocation by two percentage points.

In his weekly note to investors GREED & fear, he added that if Indian equity markets correct sharply in an aggravated tapering scare, the weighting will be added to.

“GREED & fear remains structurally positive on the Indian market despite the lofty valuation at 21.5 times 12-month forward earnings which creates certain vertigo,” he said.

Wood further added that a new property cycle has commenced, a broader capital spending cycle should be coming sooner or later while the best companies have profited from deleveraging triggered consolidation in sectors like residential property and housing finance and indeed consumer finance in general. Meanwhile, the central government remains firmly pro-growth.

“GREED & fear has no such asset allocation problem in the Asia ex-Japan long-only portfolio where the biggest bets are on Indian domestic names and where the performance is reflected in an outperforming market given the allocation is to specific stocks. At present 31% of the portfolio is in India,” said Wood.

His views came at the time after most Federal Reserve officials at the central bank’s July monetary policy meeting believe it will be appropriate to begin tapering asset purchases this year, according to the minutes of the meeting released on Wednesday. The benchmark BSE Sensex traded 257 points, or 0.46%, down at 55,373 in the afternoon trade on Friday. Indian equity markets were closed on Thursday on account of a public holiday.

While there was still some disagreement over the timing of tapering the asset purchases, the US dollar index surged on these comments, breaking above the 93 mark to scale up the highest level in nearly 8 months.

“The major risk to GREED & fear is the arrival of a new Covid variant. But that is a risk shared with the rest of the world. Otherwise, the other risk is a change in the central bank’s doveish policy. The Reserve Bank of India has been raising its inflation forecast in recent meetings but has yet to signal a change in policy,” said Wood.

The RBI raised its CPI inflation forecast for this fiscal year to 5.7% in its policy meeting on 4-6 August, up from 5.1% projected in June. Still the RBI’s bond purchases under the Open Market Operations (OMO) programme have continued while there is no talk as yet of rate hikes . The policy reporate is currently 4.0%.The next RBI meeting is on 6-8 October.

From a market standpoint, Wood added that tapering is coming sooner than expected could well cause some jitters in the risk on trade in equities, and give a reason for treasury bond yields to move higher since the market assumption will be that an earlier than expected commencement of tapering will be bearish for treasury bond prices since it means less Fed buying of treasuries.

This is despite the fact that the almost 13-year history of quanto easing and tapering cycles in a deflationary era shows that tapering has been bullish for treasury bond prices because it is a form of monetary tightening while central bank asset purchases, and related balance sheet expansion, have been bearish for bonds since it amounts to a form of monetary easing.