Markets will remain under pressure

Spooked by the increasing bond yields and fear of rising inflation in the US and the concerns over a second wave of Covid cases; markets witnessed a serious correction on the last day of the week ended.

The Sensex slumped 1,789.77 points or 3.52 per cent to 49,099.99, and the Nifty corrected 452.60 points or 3.02 per cent to 14,529.15 during the week. After this fall, both the benchmark indices are around 6 per cent lower from recent record high levels.

However, the broader markets outperformed frontline indices last week as the Nifty Midcap 100 index and Smallcap 100 index gained 0.65 percent and 0.87 per cent respectively. The biggest single-day FII outflow (of Rs 8,295 crore) since November 3, 2017on February 26 triggered weakness in rupee which depreciated to Rs 73.46.

Observers fear that the rise in US bond yields may force FIIs to pull out money from emerging markets like India and could also be a risk for emerging markets currencies. By and large, bond yields are inversely proportional to equity returns.

When bond yields rise, equity markets tend to underperform. The Taper Tantrum of 2013 is infamous for how the sudden rise in bond yield caused equity markets to slide, as it resulted in mass selling of bonds.

At present, FY22 Nifty PE stood at 22 times resulting in an earning yield value of 4.54 (1/forward PE multiple or EPS/price). With bond yield at 6.18 per cent, BEER ratio stands at 1.36.

A value above 1 suggests equities are overvalued. For this ratio to come down, either bond yields need to fall or earnings yield needs to rise. The risks to equities are that bonds offer better value than equities at current levels and/or inflation surges says a report of Morgan Stanley.

It is pertinent to observe that the cryptocurrency Bitcoin slumped as much as 20 per cent this week showcasing that risk-on assets are taking a hit at the moment. Reports of India's third quarter growth at a marginal 0.7 per cent, signalling the economy's exit from the pandemic-induced recession were the only bright spot during the week ended.

Heard on the street

Despite signs of an improving world economy, rising bond yields blunted stock markets momentum across the world during the week ended. Government spending and the aggressive monetary policy of Central Bank's across the world have supported the stock market during a tumultuous year.

But those two sources of stimulus are now fuelling inflation bets and sparking a bond selloff. When bond yields were at their lows, they offered investors virtually no returns or even negative returns in some countries after inflation. The lack of returns on bonds drove investors to stocks, pushing valuations to their highest point in years.

Now that bond yields are rising, those richly valued stocks look less attractive. Everything is divorced from the risk in those instruments. Everything is mispriced. Markets are increasingly dominated by momentum.

Expectations among some investors that inflation will climb sharply prompted concern that the Central Banks of some countries may increase interest rates sooner than previously anticipated, which could potentially boost borrowing costs and weigh on economic growth.

The Central Bank's across the world can either fight the bond market by ramping up its bond buying, or abandon its dovish policies, or do nothing and hope it goes away, he said.

All options would have different ramifications for the markets and economy, and that is making life difficult for investors. This is all coming at a time when the economic picture appears to be improving.

The fall didn't surprise say observers, many of whom say the correction was overdue as the market was trading at higher valuations and most of the positives were already factored in.

Market participants should keep an eye on bond yields and the movement of USD/INR currency pair, which could undergo some depreciation. Equity markets could remain under pressure as the normal course of correction continues to take shape.

Futures & options sector watch

Mirroring the savage sell off in the cash markets, the March series opening day witnessed sharp selling in the derivative segment. Rollovers were in line with three month averages. However, many traders say that rally during the early part of the week ended followed by sell off on Friday is 'bull trap'.

The maximum Call options OI was seen at 15,000 strike, which will act as a crucial resistance level in the March series, followed by 15,500 and 15,200 strikes, while the maximum Put options OI was seen at 14,000 strike, which will act as a crucial support level in the March series, followed by 14,500 strike.

The recent surge in the metal prices led to a rally in the index whereas the improved manufacturing scenario in China helped the indices to record gains. Use declines to buy JSW Steel, Tata Steel and SAIL. Auto stocks will be in focus as sales data for the month of February will be released on Monday.

Industry sources indicate muted two wheeler sales and mild uptick in passenger vehicle sales; and buoyant tractor and commercial vehicle sales. Buy Tata Motors, Escorts and M&M.

The Finance Ministry dictat to allow private banks to participate in government business would be beneficial for the smaller private banks like IDFC First and Bandhan say industry insiders.

Stock futures looking good are BPCL, HDFC, IRCTC, Navin Flouro, SAIL and Tata Chemicals. Stock futures looking weak are Bajaj Auto, L&T Finance, RBL Bank, PVR and Zee.

Stock picks

Hindustan Oil Exploration Company Limited is the first private company in India to enter the field of oil and gas exploration. HOEC has 10 blocks with discoveries producing or ready to be developed and 1 exploratory block in its portfolio.

Gross Production stood at 7,869 boepd and Net Production stood at 3,163 boepd for FY20. Proved and Probable (P+P) reserves on working interest basis stood at 26.65 MMBOE as on FY20. Able to fund capex from inner accruals and raise funds as needed for growth.

Awarded the Oil & Gas production & Development Company of the year in 2018-19 from FIPI. The competitive Advantages of the company include uniquely placed with a strong organisation and a quality asset portfolio. HOEC will take advantage of its position to deliver superior returns and value to all stakeholders, through a 5-pronged strategy, focus on discovered resources, and light asset model, and low cost operating model.

Why we are recommending the company:

• Presently Oil & Gas industry is again in upward cycle. Results of Q3 of the company reflect the buoyancy for company in coming days.

• The company has started production from new fields

• Possible exceptional gains from the new fields

• Ex-Chief of Cairn India is now managing the company.

Buy between Rs 90-100 for medium term (nine to twelve months) price target of Rs 160 - 200. In the event of sharp correction in the broader market, stop loss should be at Rs 75. We are looking at a risk reward ratio of 1:6.

(The author is a stock market expert. He is former vice chairman of AP Planning Board)