Strategy: Stocks rise on hope of economic recovery by H2FY21 amidst slowing QE! - ICICI Securities

Market outlook: Economic recovery slowing in Q2FY21 as per Q1FY21 management commentary, RBI's latest survey of manufacturing firms, consumer confidence and high frequency indicators like PMI. On the positives, corporate cashflows are improving on resilient rural demand, government payments and ample liquidity. However, expectations of demand recovery by H2FY21 have started getting 'priced-in' by equity markets (Nifty forward P/E exceeds 1 s.d.), but the recovery is contingent on: 1) India's COVID-19 curve during Q2FY21, and 2) improvement in consumer confidence towards 'future expectations', which incidentally picked up for the first time since COVID-19 began.

Evidence of a slow but surely improving global economic environment, earnings beat in Q1FY21 so far and continued commitment by central banks for continuing QE - has the potential to keep markets expensive in the near term.

However, India is lagging the global recovery and a faster than expected recovery in the developed world could hasten the signalling of a pause of QE by the US Fed in the near future and could be a key risk for EM equities. US FED balance sheet expansion has stalled since June and has actually dipped marginally in July which could be an early sign of the pause to the first round of QE during Covid-19 times.

Other key risks for India include; worsening of NPA's (baseline forecast by RBI of 12.5% for FY21) and high combined fiscal deficit of the centre and state government.

Key macro trends from management commentaries in Q1FY21

- Economic recovery slowing in Q2FY21 and hopes of demand recovery deferred to H2FY21: Management commentary from Q1FY21 indicates improvement in utilisation levels of manufacturing firms from April'20 lows but showing signs of stagnation in Q2FY21 after reaching ~60-80% levels. To be sure, utilisation level was already low at 69.9% in Q4FY20 (76% in Q4FY19) as per RBI's OBICUS survey.

- RBI's latest survey of 802 manufacturing firms also indicates weak business expectations for Q2FY21 and sharp dip in consumer confidence in the 'current environment', which is corroborated by macro data points (India PMI contracted further in Jul'21 to 37.2).

- Urban demand for discretionary consumption and organised retail continues to be weak while private capex is getting deferred. Hotels and Leisure industry continues to be impacted severely.

- Global demand for IT exports is likely to dip, but not significantly, while pharma is expected to show idiosyncratic growth.

- To be sure, India is lagging the global economic recovery with global-PMI going into expansion territory in Jul'20 led by Europe, US and China, which have largely controlled a significant flare-up of the second wave of Covid.

- Base case scenario by RBI is of NPAs rising from 8.5% in FY20 to 12.5% in FY21 while management commentaries of most large banks are cautiously optimistic.

- On the positive side, rural demand is supporting 'private consumption' as well as 'gross fixed capital formation' (individual homebuilding and jump in MGNREGA spend). Unorganised segment (Mom and Pop stores) involved in retailing of essential products are witnessing a demand boost.

- Company cashflows are improving as government payments improve, liquidity in the system is ample, and rural cashflows are getting better. Early signs of higher ordering from government for infrastructure projects are visible.

- Input costs are largely under control and reflected in WPI decline (-0.58% in July)

- Robust retail-deposit growth and declining retail loan growth indicates increased net savings by households, which is positive for the investment cycle.

Source : Equity Bulls

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