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Market internals do not indicate ‘risk aversion’ as high beta, small/midcaps and high dividend yield outperform in the current phase of market weakness driven by spike in US yields

Consolidation and sector rotation rather than a systematic rise in risk aversion: While the benchmark NIFTY50 index is down 2% from the recent peak of 15,300, there is no sign of any sharp increase in ‘risk aversion’ given the moderate increase in fear index (VIX at ~25) and outperformance of strategies such as high beta (+4%), CPSE (+9%), smallcaps (+5%), midcaps (+3%) and dividend yield (+2%) strategies continuing to outperform (we have been positive on the above strategies: Links - PSUs, dividend yield and small/midcap). Sectorally, the performance is led by metals (+8%), power (+7%), energy (+7%), media (+4%), infra (+2%), consumer durables (+1%), PSU banks (+1%) and realty (0%). On the flip side, heavy weight underperforming sectors include banking (-5%), auto (-4%), pharma (-5%) and telecom (-7%). Defensives like FMCG and IT were largely in-line with market performance.  Normalisation of bond yields driven by ‘fear of inflation’ on faster-thanexpected growth; no impact on liquidity as central banks hold accommodative stance: The rise in US bond yields is causing volatility in global capital markets over the past two weeks but as articulated in last week’s memo (Link), underpinnings driving the rise in yields (faster-than-expected growth driving inflation) are largely positive for equities unless inflation and yields go out of hand which appears unlikely. In our view, equities as an asset class performs better in an environment of ‘rising growth’ and ‘moderate inflation’. Last print of inflation for Jan’21 indicates CPI was benign at ~4% although core inflation remains sticky at 5.3% along with manufacturing inflation within WPI elevated at 5% reflecting pricing power of manufacturers. Input cost pressure was indicated by most manufacturing firms during Q3FY21 call.  High frequency indicators for Feb’21 indicate Q4 earnings should continue the strength seen over the past 3 quarters given the robust GST collections (Rs1.13trn) and MoM expansion continuing for both manufacturing and services PMI at 57.5 and 55.3, respectively. India has consistently been amongst the top countries for the past couple of months in terms of expansion in manufacturing activities based on global PMI data. However, exports dipped marginally (-0.25%) in Feb dragged down by petroleum products (-27%); ex-petroleum exports grew 3.55%. Non-oil & gold imports rose 7.4% indicating demand revival continuing in domestic economy.

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