The sharp increase in the number of active Covid-19 cases over the past few weeks and continued high inflation may undermine the key drivers of the equity market — expectation of a strong economic recovery and robust earnings growth in 2021-22, Kotak Institutional Equities said on Wednesday.
“We will probably see many investors go back to defensives like pharma and IT. This rotation may happen over the next couple of months,” said Amit Kumar Gupta, Head of PMS at Adroit Financial Services.
Exactly a year back as the government enforced a lockdown to stem the spread of the pandemic, investors started buying pharma stocks, counting on a possible bump up in the sector’s earnings.
However, as the Covid situation improved and vaccines rollout began, the probability of a sooner-than-expected normalisation of the economy made investors to rotate funds towards cyclical sectors and banks. Nifty Pharma index has slipped 7 per cent so far in 2021, underperforming Nifty50’s 4 per cent gains, after rising more than 60 per cent in 2020.
Of late, though, the emergence of a second wave of infection in the country has led to some dialing back of the enthusiasm for the cyclical sectors.
The risk to Dalal Street’s corporate earnings expectations from another round of localised lockdowns comes at a time when stock valuations are near their lifetime highs, making them vulnerable to bouts of selling as was evident from Wednesday’s selloff.
In such a scenario, fund managers expect investors to flock to the safety of consistent earnings being provided by sectors like pharma and IT.
Brokerage firm CLSA Asia-Pacific Markets in a recent note said that it “remains confident of 19 per cent annual growth for Indian pharma, led by improved margin outlook.” The weakness in pharma stocks from the start of the year can also be explained by concerns among investors over sustainability of the strong margin performance during 2020-21 given that it was propped up by one-off cost savings.
“While FY22 margins should drop, the product mix led an improvement in US and India along with operating leverage benefits should drive margin expansion in FY23 (2022-23),” CLSA said.
While pharma stocks may not be able to replicate the mind-numbing returns of April-September 2020, analysts believe the improved earnings and return on capital employed should ensure that they remain attractive bets compared with the froth seen in some parts of the market.
In a market showing signs of retracing some of its stratospheric rise from the multi-year lows of March 2020, a dose of pharma stocks may help calm the nerves of investors.