The last week was the start of the results season and we saw a few large companies report earnings. Stock Markets continued to rally, albeit at a slower pace with the Nifty rallying by around 1.5% with the Midcap Indices also rallying by the same amount. The confidence of a V Shaped recovery is growing as the markets continue to rally albeit the on ground situation does not support the argument at this stage.

We saw results come out from two bellwether stocks with TCS reporting numbers that were way below expectations. They talked of bottoming out and being bullish about the future however the valuations of the stock more than take into account any slow recovery. Taking into account the earnings decline of this year and growth for next year over a two year period earnings for technology companies will be flat for the next two years. Avenue Supermarts also reported end of the week. While revenues were in line with expectations the earnings decline was much sharper than expected.

It is important to understand “OPERATING LEVERAGE” i.e. the impact on profitability with spike or decline in earnings due to higher growth or decline in growth. Most analysts in my view currently are underestimating the impact of lower growth on earnings as lot of costs of companies are fixed in nature. For example for DMART while the expected operating profits were around Rs 180-200 Crores actual were just around Rs 110 Cr. This will be seen across the board and will lead to earnings downgrades as we come to the end of the quarterly results season.

The bigger concern at this stage is the Covid picture of India and also globally. Yesterday we had the biggest single day spike of around 28000 cases. Many states and cities have announced renewed lockdowns for periods of 2-15 days which includes large cities like Benguluru, Pune, Mumbai, all cities of UP etc. Movement restrictions continue in many states. New hotspots have come up as cities have opened up. In my view good quality masks are the only solution along with avoiding crowded places. Disruptions in businesses and lives on a continuous basis will be tough for the bruised Economy to take. The IIP Data for May was declared and showed a fall of around 35% for the month. Next months data will be more critical to see as many companies have claimed normal operations in June. Worldwide Covid cases also continue to grow on a day to day basis.

The current consensus estimates for earnings for this year for the Nifty is an EPS of around Rs 440-450. The actual delivery is likely to be more like 400. On that the analysts are building in a 30-35% earnings growth next year which is very optimistic but could be possible if Covid gets controlled (which it should by next year) and inflation doesn’t spike up. As per these estimates markets are now trading at around 19.5-20 P/E ratio for next year which is the highest since January 2008.

The valuations of the US Stock markets are nearing all time highs with the US Market Capitalization to GDP ratio at around 160% now the highest ever.

In a large market and economy with low interest rates individual investment opportunities will always be there, however the market wide index rally seems to have played out largely. Deep Value contrarian bets that will work once normalcy returns in 2021 could still be multibaggers for long term investors.

The market momentum has been too strong and has proven sceptics wrong till now. The technical picture still doesn’t show weakness thus keeping traders bullish.

I will close out this weeks piece with the following wise words

Even the intelligent investor is likely to need considerable willpower to keep from following the crowd. – Benjamin Graham

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