The year 2021 saw Nifty50 jump by 24% thanks to record retail participation and inflows by foreign investors. This was the third consecutive year when the 50-share index incurred double digit gains after 15% and 12% returns, respectively in 2020 and 2019. As we enter 2022, investors are on tenterhooks. The Covid-19 cases are rising. Partial lockdowns have been announced in different states. Budget 2022 is round the corner while assembly elections are lined up in seven states. Globally, the U.S. Federal Reserve is all set to raise interest rates, which has triggered FII outflows from emerging markets, including India.

“Market valuations are on the higher side even after the consolidation. So, the stock market is vulnerable to disruption and high volatility. Key risks include drop in liquidity due to hawkish monetary policy, rise in inflation and yield, weakness in economy and rise in geopolitical issues,” says Vinod Nair, Head of Research at Geojit Financial Services.

We give you critical developments that can halt the stock markets bull run in 2022:

Rising Covid-19 cases

New year and the new variant Omicron, which is highly transmissible. The Omicron cases have been consistently on the upside. India now has 2,135 Omicron cases, with Maharashtra and Delhi leading the tally at 653 and 464 infections, respectively. The overall Covid-19 cases have been rising for the last seven days, with 58,097 fresh infections reported on Wednesday, January 5. Partial lockdowns and night curfews have been announced in different states.

“In the near term, the rapid spread of Omicron can worsen lockdowns, supply bottlenecks, inflation and hence there could be sharper liquidity withdrawal by central banks,” says IIFL Securities in a research note.

State elections

Year 2022 has seven state assembly elections lined up. Uttar Pradesh, Punjab, Uttarakhand, Goa and Manipur will have it in the first part of the year while the elections in Gujarat and Himachal Pradesh will take place by the end of the year.

“We can expect some populist measures to be announced in the budget. However, these could be in tandem with the weakness in rural and under-privileged sections due to loss in income led by the pandemic. This is unlikely to affect the long-term fiscal policy, but an impact in short-term is expected. Market may remain cautious during this uncertain period,” says Nair of Geojit.

Vinit Bolinjkar, Head of Research at Ventura Securities feels the government can frontload its capex plans for employment generation in the run up to elections or it could announce income tax benefits in Budget 2022 for individuals.

US Fed rate hike

The monetary policy in the U.S. plays a major role in how stock markets in emerging economies perform. Fed chief Jerome Powell has announced three rate hikes of 25 bps each in 2022. The first one is expected by June 2022. This has already triggered FII outflows from India, putting pressure on benchmark indices. Foreign investors sold equities to the tune of ₹19,000 crore in December itself.

“Transition to 2022 will see a more normal monetary policy, and investors could do well to expect more moderate returns from financial markets. Central banks will start to raise rates but remain more tolerant of inflation. Central banks and their assessment of economic conditions will likely be front and centre once again in shaping investment strategies in 2022,” says Deepak Jasani, Head of Retail Research, HDFC Securities.

Corporate earnings

Earnings outlook has to be seen in the context of an expected hike in interest rates. “Interest rates are surely going to dent corporate earnings. Earnings will also have an impact due to commodity prices and the ability of the companies to pass on the increased costs to the consumers,” says Bolinjkar of Ventura Securities.

What is positive, however, is the corporates have deleveraged well. “The impact of rise in interest rates during 2022-23 will be low. However, it will have an effect on companies with heavy balance sheets, and those in infrastructure and core sectors. This has to be reviewed in the context of rise in business due to capital expenditure and growth in earnings. This is also expected to be positive for banking sector,” says Nair of Geojit.

Valuations

Nifty50 index is trading at one-year forward earnings of 21x, which is about 18% higher than seven-year average of 18x. This is even as the Nifty has fallen over 5% from its all-time high, hit on October 19, 2021.

“Post a super show in 2021, valuation levels in Indian equities could make most people cautious on India within emerging markets and Asia,” says Jasani.

However, there are reasons why the country will continue trading at a premium. “Indian market still has the potential to positively surprise, as its macro construct — GDP growth, tax collections, flush liquidity, the start of a capex cycle, a listing of startups leading to risk-on sentiments, supportive monetary policy, better than expected pace of macro recovery post-pandemic, likely inclusion of Indian bonds in the global bond index by Q2FY22 and strong vaccination drive — and earnings remain largely supportive,” says Jasani.

Making money in the stock market has been a cakewalk over the last couple of years. Be cautious as the year 2022 passes by. “Bottom-up approach will be the flavour of 2022 as period of easy money is now surely behind us,” says Bolinjkar.

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