‘Keep a close eye on earnings trajectory’

After a dismal 2019-20, the markets are primed for a strong revival in earnings. The trajectory of earnings growth will be the most critical factor that will influence the markets, as valuations, boosted by benign monetary and fiscal policies, are at an elevated level.

Due to the pandemic and the lockdown during the June 2019 quarter, earnings were downgraded sharply for 202021. GDP estimates forecasted 10 per cent and even 15 per cent degrowth. However, the swifterthan-expected economic recovery led to a more robust September quarter. Upgrades then exceeded downgrades three times, a rarity, after years of earnings disappointment. Estimates for 2020-21 rebounded quickly from negative to positive territory, despite the debacle of the first quarter.

However, 2021-22 and beyond is what investors are playing for now. In the past, the track record for forecasting two-year forward earnings growth has been poor, with actual earnings coming in lower by 25-30 per cent. Currently, estimates for 2022-23 appear to be building growth rates higher than the peak growth achieved in any period during the 2013-19 phase across sectors.

Pockets of value are available in four buckets. The first is PSU stocks, comprising banks, refiners, metals, mining, and heavy engineering companies. The second is corporate lending focused and mid-sized banks. The third is cyclical sectors, including industrials, automobiles and auto ancillaries, and metals and commodity companies.

The last bucket is small caps. If the economic recovery is robust and the RBI does not move aggressively into a high real interest zone, small caps could benefit the most. This was reflected in the market recovery after a sharp fall in 2009 (global financial crisis), 2014 (general elections), and 2017 (post demonetisation) as well.