Equity Volatility May Be On The Rise…

The equities have turned more volatile in the past one month and it is grappling with a number of factors both internal and external which makes the onward journey slightly more uneven. The earnings season is coming to a close and the complete picture of the Q2 FY22 earnings would emerge in the coming days. Overall, the earnings season has progressed very satisfactorily till now. As evident from the results, things are gradually but surely reverting to pre-pandemic levels. The sales growth which had fallen by 5% for Sensex and 7.5% for Nifty in Q2FY21 has risen by 22.7% and 32.4% for Sensex and Nifty respectively; similar trend for top line was seen for broader markets as well.
While sales growth moved on expected lines the EBITDA margins took a hit in Q2FY22. The raw material cost pressures and inability of corporates to raise prices to support sales growth has led to margin pressures. This stands in direct contrast to what we had seen in the second half of Q1FY21. During that period, the sales growth was largely stagnant, but the bottom line improved as there were no margin pressures. Currently, we have a scenario where the sales growth is improving, while there is some margin contraction. The EBITDA margin had improved by 406bps in Q2FY21 as compared to the year ago period for Nifty; the margin for Q2FY22 has contracted by 207 bps for Nifty. The markets may not necessarily see it as a concern if the sales growth continues to improve. A continuous improvement in sales will be an indicator of the strength of recovery and this may translate into better pricing power for the corporates. The earnings season has also been satisfactory in terms of earnings upgrades. A higher number of companies have seen their earnings estimates being upgraded or maintained as against being downgraded.
Inflation definitely has an outsized impact on corporate earnings. While the focus is mainly on commodity or raw material inflation, the inflation in other factors of production is largely ignored when it comes to popular discourse. The commodity inflation will definitely hold sway over corporate earnings and margins in the near term, but what we believe will have a slightly long-term impact is the wage inflation. Few of the corporates are already facing labour shortages and if the economic growth continues to improve with the
private capex also coming through as expected the wage inflation can be the second inflation wave after the commodity inflation. As discussed above, the hit of the commodity inflation over the near to medium term would be dependent on the pace of the recovery, better the recovery better the pricing power.

The earnings outlook for H2 FY22 is very constructive, as the economic recovery which is underway expected to be broad based one. Over the last few years, the markets mainly focused on the B2C companies as they tried to avoid capex driven plays and leveraged companies. The level of leverage has come down drastically which improves their ability to borrow and largely asset quality issues of banks have also been addressed, improving their ability to lend. Along with B2C the B2B segment is also expected to witness healthy earnings growth. In the view of industry experts, after a gap of many years the future capex outlay of private corporates is higher than that of the government. We expect near term earnings to continue to improve and the medium- term outlook too is equally robust. The approach to markets should be in the phased investments or systematic format to take advantage of any corrective downward movements in the near future. With normalization of liquidity gaining prominence both in India and the US, the markets could turn more cautious, and evaluate the impact of likely hikes in interest rates in early 2022, in the event of inflation staying persistently high. This is where funds and products with value theme, or graduated investments mode like in some select alternate investment funds (AIF) becomes more relevant, apart from hybrid strategies like Balanced Advantage Funds.


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