Markets to be tested as some sections of the economy may hit a wall

The end of the worst quarter for India and for global economies is around the corner. Earnings growth is most likely to be a washout for many companies. Some of the best companies, even consumer facing businesses that were running a tight shop throughout the pandemic, will not be immune to earnings slowdown in the first quarter.

Even while some high-frequency data such as the Purchase Managers’ Index to be released next week may show a bump up, the deep contraction is still visible.

Of course, stocks are defying the economic reality. The market was quick to rebound after a sell-off driven by anaemic prognosis by the International Monetary Fund. There’s no denying that the global excess liquidity is far stronger than the economic reality at the moment.

But some of that limit could be tested in the coming weeks. While the market’s rise has been swift, the pickup is showing signs of tapering.

A report by Kotak Institutional Equities shows road-traffic congestion levels either flat or lower than the week prior. “We believe that different parts of the economy will recover at different speeds, and some sections of the economy may hit a wall before reaching pre-covid-19 levels,” said analysts at Kotak Institutional Equities.

Globally, more high-frequency indicators are expected to be unveiled next week. With several states re-opening businesses, the US is expected to come out with lower unemployment figures. Some improvement in manufacturing activity will also be reported from around the world. But we have to remember that even though most of these may exhibit a recovery, we are still not out of the recession woods yet. In fact, that will take a few quarters, if not more.

Some analysts are expecting more easing in the coming months and even another stimulus that could support equities. However, the persistent flow of easy money would have repercussions on swelling public debt, which should not be ignored.

The excess liquidity does seem to have its side-effects with stocks seemingly overreacting on the upside to news. The launch of FabiFlu, the local version of Favipiravir, launched by Glenmark Pharmaceuticals drove its stock to stratospheric heights. But earnings from this launch are expected to be for a limited period.

Some tyre companies are seeing volumes rise, but price realisations have been lower.

For some companies such as Info Edge (India), the opening up of the economy is key to hiring trends. But for this pricey stock, faster growth will be needed to maintain valuations.

The IT industry may not be badly hit on the restrictions on H1-B visas. Most such firms have shifted to a work-from-home model. Besides, tepid business has contained the need to augmenting on-site manpower.

For others like the highly valued Page Industries, growth is key to sustain lofty valuations. But momentum seems to have been lost in Q4.

On the consumer front, United Spirits has embarked on a program of supporting bars and restaurants. Given the lockdown, though, it will be tough for sales to improve much this year.

Some companies are defying the general downward pull. Ruchi Soya, for instance, which recently climbed out of the bankruptcy mire, has been on the rise. Before it was delisted, it quoted a puny valuation. But the runaway move has surpassed market capitalisations of well-entrenched names such as Marico.

On that front, many small caps and penny stocks have been on a tear, a flurry of trading activity. Retail investors have bulked up these counters. When the music stops, trading volumes are likely to soon dry up.

Investors should be wary of such spikes and avoid getting lured into these counters. Hardly a few succeed by moving quickly in and out of these counters, but for the vast majority, small stocks can be a minefield.

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