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Markets are at risk of not being able to meet earnings expectations for FY22 and downgrade of earnings, Satish Ramanathan, managing director and chief investment officer, equity, JM Financial Asset Management Ltd, said in an interview. If there is a third covid wave, the most vulnerable sectors will be tourism, and hospitality and travel, while manufacturing has learned to cope with it. The record number of new-economy stocks that are getting listed will reflect better in the economy, and hence, there may be a reallocation of capital in the market, he said. Edited excerpts:

Which sectors are vulnerable to a further shock if covid’s third wave hits India?

The second wave has now created adequate awareness and knowledge to cope with covid. The vaccination drive continues, albeit with bottlenecks, and 31% of India’s vulnerable population have had at least one shot. Consequently, we expect the economy to improve from here on. The most vulnerable sectors remain tourism and hospitality and travel, while manufacturing has generally learned to cope with the disease. What is not known, however, are the variants and the impact that they may have. If we look at the developed world, the US and the UK, two vaccine shots have reduces risks significantly, and hence, one can assume the outcomes are applicable for India as vaccination levels increase. We are currently sanguine about the economy and its outlook, but expect the rate of recovery to be more modest as compared to the first wave.

Have investors become complacent about stock markets now?

Investing in equities will continue to operate in cycles, but as an asset class it is still one of the most attractive with regard to ease of opening accounts, ease of buying and selling, liquidity, and increase in reach. The number of dematerialized accounts, as well as steady inflows into mutual funds point to the fact that retail investors are becoming a bigger force to reckon with. Working from home has also increased savings for those in organized employment. In terms of comparable assets, equities are still attractive, but on a valuation basis, they are expensive relative to historic trends. So yes, while equities may tend to nudge higher, history suggests that the unknown-unknowns could create some volatility. India is coming out of a long period of low investment in infrastructure with a focus on reducing debt. We are now seeing some animal spirits coming back and this needs to translate into entrepreneurship and investments. From that point of view, we are still a long way from the top. We are seeing a record number of new-economy stocks getting listed, which will reflect the economy better, and hence there may be a reallocation of capital within the market.

Downside risks include a third wave, vaccination bottlenecks and high inflation. Do you agree? How much will the markets correct if these risks play out?

We cannot speculate about when and how a third wave may come and, if so, the variant. The variable that we will continue to monitor, which is in our control, is the vaccination rate. As we cross 50-60% vaccination rate, we can see further pick up in economic activity and virtuous cycle emerging. As regards to inflation, there have been several reasons forthcoming, such as sudden demand surge, consolidation among suppliers and, most importantly, disruption in supply chains due to weather, covid, and geopolitical issues. Currently, central banks appear accommodative of inflation, explaining it as a transient one. Traditional commodities, such as oil and coal, are being challenged by new technologies, and this places a natural ceiling on their prices. The US 10- year treasury yield, a proxy to inflation expectation, has increased 71 basis points on a one-year basis, but has declined 24 bps on a three-month basis, indicating that expectations of a surge in inflation is muted. The reallocation of capital from traditional bank savings and bonds is expected to continue for some time, mitigating risks of a long-term structural correction that we have seen in the past.

Will the earnings momentum continue through FY22? Which sectors will drive growth?

There is a risk to FY22 earnings expectation not being met and earnings being downgraded. Commodities and the banking sector are expected to contribute to the growth in earnings followed by other sectors such as chemicals and export-oriented industries. The auto sector will have a rebound later this year as lock downs are lifted. We expect the increase in operating margins that we witnessed last year to take a hit due to rising input and wage costs. Businesses are also hit by shortage of workforce and unavailability of raw material in time due to staggered lockdowns in various states. Our expectation is that there will be a good recovery, albeit a lower one compared to FY21. This may cause some disappointment in the second half of the fiscal year.

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