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Inflation fears mixed amidst improving growth outlook with ‘value rotation’ continuing; rise in Covid cases keeps risk appetite lower

* Value rotation continues as US equities hit all-time high on subdued inflation, steady growth and central banks (ECB & US FED) pledging an accommodative stance…: US core CPI for Feb’21 was subdued at 1.3%, while core PCE inflation which the US FED tracks for inflation targeting printed at 1.5% for Jan’21 against their target of 2%. Both the ECB and US FED reiterated their accommodative stance until employment levels rise to pre-Covid levels and inflation expectations are well entrenched above their target range. A combination of the above factors resulted in US equities rising beyond the volatility caused by rising yields since Feb’21 to hit an all-time high with ‘value rotation’ continuing. DMs including US equities outperformed EMs including India over the past one week.

* …while for India headline and core CPI rose to 5% and 5.9%, respectively, in Feb’21 along with improving economic activities (PMI, GST, auto sales etc.); On the flip side, Jan’21 IIP contracted more than expected at -1.6%. For India, headline CPI rose sharply to 5% driven by food and fuel prices; core CPI (ex-food and fuel) also inched higher to 5.9% reflecting rising consumption demand and commodity prices. Robust GST collections (Rs1.13trn) and MoM expansion continued for both manufacturing and services PMI at 57.5 and 55.3, respectively, for Feb’21. However, lagged data for IIP for Jan’21 contracted to -1.6% driven by manufacturing (-2%) and mining (-3.7%), while electricity (+5.5%) remained robust. On use-based classification, capital goods (-9.6%) and consumer non-durables (- 6.8%) dragged IIP.

* Rising Covid-cases and elevated oil prices are key risks for Indian stocks. As articulated earlier, an environment of economic revival and moderate inflation has been positive for stocks (Link) augmented by an accommodative stance of most central banks. However, key risks emerging for Indian equities include: (a) Rising Covid cases in key industrial states like Maharashtra, which can slow down the nascent economic recovery although availability of vaccines provides confidence of tackling the issue unlike the situation a couple of months ago; and (b) further spike in oil prices can impact demand, CAD and government finances although sustained increase from current levels appear unlikely given the temporary disruptions on supply side.

* Earnings growth or upgrades will drive equities going ahead as valuations remain elevated on most indicators: Forward P/E at + 1 s.d. of ~ 21.7x , P/B is above LTA at 3.6x and Bond yield spread over earnings yield is 160 bps. Market cap to trailing GDP is 107% while on forward GDP, the ratio stands at 93%.

* Despite the turbulence in equity markets caused by rising bond yields, overall FPI flows have recorded inflows of US$950mn while DII outflows have tapered down to US$61mn in Mar’21 so far.

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