One thing that we have all learned from the past two years is that we definitely don’t know what will happen in the new year - the crystal ball has grown cloudy. Still, we try to find patterns that give us an insight into what may occur. With India in the middle of a third wave of the pandemic, it’s tempting to think that this time markets will be resilient.

With global central banks unwinding their emergency liquidity support measures, an adjustment in asset prices might be on the cards. The Reserve Bank of India (RBI) also plans to mop up excess liquidity in the financial system, but rate hikes, while anticipated by the markets, might take longer to materialise. This is where the RBI’s stance differs from global central banks.

Although the Nifty 50   is trying to surpass 18,000 levels, growth in earnings tempered the trailing 12-month price-to-earnings multiple of the benchmark index at 24.74 compared to its two-year average TTM PE of nearly 30. Similarly, the Nifty 500’s TTM PE of 26 is below its two-year average TTM PE of 32.71.

Essentially, companies delivered on earnings expectations of the markets in 2021, which made Indian equities look slightly less expensive compared to H2FY21. Still, there seems to be a divergence between domestic and foreign brokerages on the prospects of the Indian stock market in 2022.

Diverging views among domestic and foreign brokerages

Foreign brokerages like CLSA, UBS, Morgan Stanley, and Goldman Sachs feel it’s time to book profits   in the Indian market. The common narrative in this seems to be the high valuation of Indian stocks, impending pressures on margins due to higher input costs driven by a surge in commodity prices, including crude oil. There is some doubt about the ability of Indian companies to pass on these price hikes to the end customers.

Then there is the divergence   in the wholesale price inflation (WPI or inflation at the factory gate) and consumer price inflation or retail inflation (CPI). While November 2021 WPI rose to 14.2% (the highest level since 1991), CPI was at 4.9%. CLSA feels that this shows the inability of businesses to pass on the rise in input costs to end customers. Any attempt at passing on these costs is hurting demand, and Indian FMCG companies like Britannia are instead tweaking product sizes and grammage to protect margins. 

The global supply chain disruption is leading to higher input costs for manufacturing and other services companies, but even IT services are facing a spike in salary costs and attrition.

Among Indian brokerages, Kotak Securities took a calibrated view in its 2022 outlook   for the Indian markets. It identifies two major risks - the new waves of the pandemic dampening economic growth globally and persistence supply chain issues at least till June 2022. But it also expects earnings of Nifty 50 companies to grow 34.5% YoY in FY22, 16% in FY23, and 13.3% in FY24. HDFC Securities feels that once crude oil crosses $80 per barrel, the trajectory of the benchmark indices could be impacted.

Mixed indicators: GST collections point to economic recovery, but IIP and PMI not so much

A dichotomy here is the consistent month-on-month rise in gross goods and services tax (GST) collections since August 2021. While gross GST collections peaked in April 2021 (indicating GST for March 2021, and not April 2021), it fell considerably in June 2021 to less than Rs 1 lakh crore. This shows that another wave of the pandemic may considerably compress the collections from this levy.

Then comes the conundrum of the Index of Industrial Production or IIP. Although GST collections have been rising since August 2021, IIP saw muted growth of below 4% in September 2021 and October 2021. The latest data is not out yet.

When we look at the trend for purchasing managers’ index for manufacturing or PMI, it indicates continuing robust manufacturing activity. PMI of above 50 means growth in manufacturing activity over the previous month. One thing that investors should keep in mind, as visible in the graph below, is that movement restrictions due to another Covid-19 wave will impede manufacturing activity.

Although IIP shows slowing manufacturing activity (a lagging indicator), PMI indicates robust manufacturing activity persisting since July 2021. In case you are wondering why we didn’t look at GDP numbers, considering last year’s growth number was depressed due to lockdowns, this creates a low base. As a result, we chose to use other indicators as a proxy to analyse what could happen under the cloud of a third wave.

In all, investors know that the markets are buoyant, but are hoping for the moon. In such an environment, companies need to deliver on robust earnings and revenue growth expectations come earnings season. But there’s many a slip between the cup and the lip.