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Strong economic recovery to support markets

The Indian economy has rebounded strongly post the second Covid wave with highfrequency indicators pointing to a V-shaped recovery to pre-second wave levels.

While manufacturing had led in the initial phase of the rebound, gradual withdrawal in restrictions has led to a strong rebound in the services sector since Aug '21. We expect the economic recovery process to continue led by strong festive demand and continued acceleration in the services sector. Significant progress on the vaccination front will restrict the fallout from any possible third Covid wave.

Going ahead, we expect banking and consumer-facing sectors to drive the markets given an expected rebound in earnings in H2FY2022. We also remain positive on the IT sector given the structural up-shift in the medium-term growth trajectory for the sector. Although on a P/E basis the Nifty is trading above its five-year average, ex of IT and RIL, the Nifty is still near its five-year average which provides comfort.

Improvement in Covid situation and progress on vaccination are key positives

The Covid situation in India has improved significantly as the new cases on a 7-day rolling average are now at ~15,000 per day from the peak of ~4 lakh per day in May '21 despite the withdrawal of restrictions. Significant progress has been made on the vaccination front with over 75% of the eligible population being partially vaccinated. Going by the current pace of vaccination it is estimated that the entire eligible population will be fully vaccinated by the end of Dec ‘21 which will limit the impact of any possible third wave on the economy.

Domestic flows to make up for any slowdown in FII flows due to tapering

Given the strong rebound in the US economy and high level of inflation due to supply chain issues, the US Fed has indicated that they will start with the tapering gradually from the end of CY2021. Considering the gradual pace of tapering, it is unlikely that there will be any major pullout by FIIs though there will be a slowdown in inflows. However robust mutual fund flows along with a continued increase in direct retail participation will more than make up for a slowdown in FII flows.

Banking, consumption, and select cyclical sectors to do well along with IT

We expect the banking sector to lead the markets from here on given the strong rebound in earnings in H2FY2022 due to the pick up in AUM growth and decline in provisioning. We also expect sectors like aviation, consumer durables, hotels, multiplexes, and real estate to do well on the back of strong earnings growth in H2FY2022 due to further reopening of the economy and pent-up demand.

We expect that the IT sector will also continue to do well going forward despite significant rerating over the past year due to structural upshift in the medium-term growth trajectory. Key risks for the markets are 1) A bigger than expected third Covid wave in India which impacts the recovery process 2) Further increase in global inflation from current levels forcing central banks to tighten earlier than expected.

The Indian economy has staged a V-shaped recovery post-second wave

Since the past Diwali, India's recovery was set back by a quarter owing to the second wave during Q1FY2022. However, the recovery was equally fast with the Indian economy staging a V-shaped recovery. The mobility trends are reverting to pre-covid levels as per the google mobility index where the retail & recreation indicator has reached 96% of baseline level, public transport is up 3% from the baseline and the workplaces indicator suggests that the “back to the office” theme is picking up.

As for other leading indicators, the GST collections have also rebounded post the second lockdown and are now above the pre-pandemic levels of 2019. E-Way bill generation has been at the highest level since the start of FY2022 and the momentum is likely to pick up which will get reflected in GST numbers to come.

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