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Driven by the revival in economic activities, increased pace of vaccination and liquidity inflows, the Indian stock market has been on an upswing in the past 18 months. While valuation seems stretched every correction is bought into investors are now confused whether to book profits or to buy at current levels. To find answers to these questions and help investors how to approach trading at record high levels, Money9 spoke to Dhananjay Sinha, MD and Chief–Strategist at JM Financial.

Edited excerpts:

Q: What is your view on the current market scenario?

Sinha: The market has weathered the recent worries of China’s housing turmoil and change of stance by the US Fed towards a decisive tapering in response to higher than expected inflation with a benign outlook. The underlying assumption is probably that US tapering is a month away and narrowing of liquidity will be gradual. Also, the restatement of debt servicing for a part of Evergrande’s loan is seen as a potential resolution of debt defaults risk on USD 300bn total liability of the firm and ebbing of contagion risk for over USD 500 bn debt linked to China’s major developers. We think risks have not gone away as China is slowing, particularly its housing sector. Also we have seen over the past few speeches, US Fed has been turning more hawkish over the past 3 statements, which means there can be surprises going forward. Hence, wedged between the imminent risks and the risk-on trade, on balance the market is currently running with the bias to sustain the momentum.

Q: Besides positive macros, vaccination pace and increasing retail participation, what are the other positives that the markets are not factoring in?

Sinha: The only macro that the markets are running on is an abundance of liquidity. Ironically, a slowing economy and excess liquidity is a positive combination for the markets as it expands the valuation multiples. Surplus liquidity has existed over the past 18 months amid a combination of elevated banking sector surplus due to low lending growth, and enlargement of RBI forex reserve balance to USD 640 bn, despite moderation of FII flows in recent months.

Q: Investors are in a fix due to the market volatility as many sell shares when markets fall and soon the correction is brought into and the same shares quote at a higher from their selling price. So, what should be the strategy to book profits or chase momentum. Also, what are the early signs that investors should look out for trend reversal?

Sinha: Give the co-existence of contradicting dynamics of benign view on liquidity tapering, slowing China and emerging economies, the persistence of high inflation in developed economies, and persistence of risk factors we believe market risk premium could be on the rise. Hence, volatility can be expected to persist, interspersed by relief rallies. It will be immensely difficult to catch every ups and downs. Hence, investors should be looking at sectors and companies that are posited for cyclical and structural improvement. In our, view the next cycle for India will be led by domestic consumption stories, which should reflect in sectors such as staples, consumer goods, autos, retail lending, real estate in metros as a second derivative from the IT sector boom. In the industrial space, we think consumables, defense-related companies, and construction are preferable areas.

Q: Many believe that Evergrande could be China’s Lehman crisis. But what could be the silver lining for India from this crisis?

Sinha: The silver lining could be the stability of India’s financial system, under leveraged banking sectors, and Indian companies. The risk of course is that China’s episode and high global inflation could slow India’s growth as well. India can take this opportunity to boost domestic demand and growth by easing its tight fiscal management through the imposition of higher taxes, which has come much sooner after the modest spending expansion in the aftermath of the Covid shock, which had been the largest in the world due to complete lockdown.

Q: Unlike in the month of August, we are seeing mid and smallcap participating in the rally. Where do you see momentum coming from and which sectors are on your radar?

Sinha: The momentum in the mid and smallcap has been spectacular and it has been a repeat of the post demon-GST episode in 2017 which saw large retail participation due to prolonged depression in transaction demand for money. In particular, the smallcap segment has outperformed large caps over the past 10 months. The current relative valuations of small caps relative to large-cap segments are higher than the 2017 bubble before it crashed in 2018. Hence, it is likely that the market will be led by largecap stocks now.

Q: The pace of activities in the primary market slowed in the month of September. Do you foresee subdued activity to continue or will the primary market get their mojo back?

Sinha: Primary market activities have been guided by the broader secondary market. With markets giving good valuations, companies are finding it opportune to raise funds for purposes of expansion or capital restructuring. Broadly speaking the momentum in the primary should sustain even while there can intermittent periods of lull.

Q: Q1FY22 earnings were in line with Street estimates. How do you see Q2FY22 earnings panning out and which sectors will be leading from the front in Q2?

Sinha: Q2 earnings season will likely see recovery from Wave 2 impact and is likely to reveal the pace of demand across domestic sectors. Trends in margins and cost pressures across sectors will be keenly watched. Our channel checks and lead indicators indicate feeble demand conditions but rural sectors have held up better than expected and urban demand is improving. Broadly speaking tech sector is expected to sustain the positive momentum. The banking sector is facing growth challenges in the face of excess liquidity and a very modest pick-up in credit growth. In auto sector has been facing margin pressure, but several OEMs have taken price hikes to compensate for higher raw material costs. Passenger vehicles are expected to exhibit signs of recovery. The construction and cement sectors have stood well on the business outlook and price actions.