Half yearly Review 2021

“Trying to predict the future is like trying to drive down a country road at night with no lights while looking out the back window” – Peter Drucker

2021 has been a year of two halves – the first part from Jan till early March 2021, saw a strong social and economic recovery as India tried to recover from the first Covid wave of 2020. We were hit by a torrid second wave from April onwards. Thankfully the worst of the second wave seems to be over. As we limp back to normalcy let us all get vaccinated and remain careful. Let us take a closer look at the key equity market developments in 2021 as well as the drive for long-term equity market returns

Key Equity Market Developments in H1 2021.

In the half year gone by, we have seen the following developments:

• Resilient Equity Markets are at an all-time high – Even while a tragic second Covid wave hit the country, the Indian (and global) equity markets have seen remarkably low volatility. Drawing strength from good corporate earnings as well as high retail and institutional liquidity the markets have remained strong with hardly any drop even in April/May 21.
• Rise of the Mid and Small Caps – In CY2021, the large cap index has moved up 13%, the mid cap index has risen by 30%, while the small cap index is up 37%! Small caps have doubled in the last twelve months.
• Revival of Value style Investing – After several years, the Value style of investing (funds and investors who seek stocks at valuation discounts looking at current assets/earnings), have outperformed growth-oriented investors. This is a global rally driven by rise in commodity prices as well as earnings revivals in sectors like corporate banks, utilities and energy.

Driver of Equity Market Returns In India, there seems to be a disconnect with the markets rising even as the perceived scenario is bleak on the ground post Covid. So, what should we do now?

One indicator which has a high correlation with future long term market returns is future corporate earnings. While equity markets react to macro and liquidity events in the short run (central bank measures, war, oil prices, covid, inflation etc.), in the long run there is a very strong correlation between corporate earnings and equity market returns. Let us take an example:

• Global Technology Stock Rally from 2010 to 2020 was driven by earnings – In the last decade, The NASDAQ has given 10x returns (26% per year). But the underlying stocks have shown such strong earnings growth. For e.g., Facebook grew profits nearly 100x from 372 million USD in 2010 to nearly 29 Billion USD in 2020 in profits! These are unbelievable numbers!
• Indian Corporate Earnings in 2021 – After nearly a decade of underperformance Indian corporates reported strong earnings growth recently with corporate profits growing at 20% between 4Q of FY19 and FY21. This was driven by multiple reasons including lower provisioning (banking), higher commodity prices (metal), lower costs (IT), higher demand (pharma) etc. We will do a separate post on this topic soon.
• Outlook for Indian Corporate Earnings from 2021 to 2030 – various market trends (shift towards digitization, increase in healthcare spends, rise in commodity prices) as well as government policies (GST, demonetization, lower corporate tax cuts, PLI incentives) have led to concentration of profits amongst industry leaders in India. This is starting to show up in the corporate earnings recently and it looks likely to intensify in the coming decade.
  Summary and Way Forward:
  The Indian markets have made a strong recovery from April 2020 onwards. Based on the positive trends in corporate earnings, we remain optimistic about long term equity market returns. In an era of low interest rates, equities (both Indian and International) these returns are attractive. However, we have to brace ourselves for short term volatility. As long as we manage our emotions and asset allocation, equities will offer a sustainable way to generate long term positive returns. If you believe in the India story, do stay invested for the long run and reap the benefits.