Fundamentals begin to catch up with stocks: Will it lead to correction?

The market during the week witnessed a roller coaster ride mirroring international markets, especially the US. Post one of the most contentious elections in recent history, the most awaited inaugural ceremony of POTUS Joe Biden kept the mood of the markets elevated. Quarterly earnings performance from India Inc., too, corroborated in keeping markets cheerful, but the weight of high valuation and bullish sentiments led to profit booking at higher levels.

Corporate numbers have been exceptional, which has paved the way for flattening the valuation curve that otherwise was very steep. The magnitude of steepness was on account of prices which ran ahead of fundamentals and currently the fundamentals are merely catching up; proof being the Q3 numbers.

It is important to understand phases of the bull market as per The Dow Theory. Here, Phase-I represents the revival of confidence in the future course of business. Phase-II is characterized by the response of stock prices to the ground-level improvement in corporate earnings performance and Phase-III depicts the rampant speculation and inflation -- a period when stocks advance on mere hopes and expectations.

As stated earlier, currently, domestic bourses are somewhere between the Phase-I and Phase-II. After Phase II is over, a long drawn correction will lay the foundation for a final push to newer highs. But in the near term, it is time to be cautious and book profits.
On interpreting ground level updates in a comprehensive way, it seems we are heading for a massive inflationary price rise. Prices of basic industrial raw materials like iron and steel, copper and everything from plastic to fiber have inched up anywhere between 50-100%. This abrupt rise in prices may impact profitability of many intermediary companies. However, those whose business models have integrated value chains are anticipated to perform far better than expectations.

In addition, industrial houses with large and heavy manufacturing capabilities would have already written down their assets long back and hence, they will benefit from newer players who will have to put up capex at current prices, which will come at a far higher fixed cost. This may eventually bode well with the old and existing industrial houses who will churn higher profit margins and in turn have better profitability than new ones.

Capital-intensive players in sectors such as cement, metal and mining, forging, heavy industrial machinery and even hotels are likely to witness increased profitability with rising inflation in the economy. All in all, this bull market may see participation from all industries this time, which also indicates that this could certainly be a secular bull run than a mere cyclical one from a long-term perspective.

Event of the Week
Results from this week itself reiterate the point that fundamentals are indeed catching up with the stock prices. Case in point being Bajaj Auto that posted its highest-ever quarterly profit and revenue on account of exports and improved domestic sales aided by festive push and demand for personal mobility during the pandemic.

Not only this, Asian Paints, too, witnessed a 62% YoY jump in bottomline, while its topline zoomed 25% and margin improved to 26.3% from 21.9% a year ago. The paint-maker, too, posted its highest-ever revenue, profit and EBITDA in Q3. A number of other companies from various sectors also beat expectations and surprised market participants. The prices, which had moved ahead of fundamentals, are now catching up

Technical Outlook
Nifty50 closed the week on a negative note after a weak opening. The index made an outside bar and it seems like it has started to feel the turbulence, as it is already trading in an overbought zone. The week remained highly volatile with a bullish tilt, which could continue unless Nifty breaks below the 14,200-mark, which is its immediate support in the short term. A break below the same can trigger a huge profit-booking move to 13,100 on the downside.


Considering the time period of the up moves, it would be interesting to see that previous phase and the current phase coincides, which hints that a bigger correction could play out this time around. Hence, traders are suggested to be light on the long side.

Expectations for the week
The next week would be filled with expectations from the Union Budget, which could be the key trigger to set the mood in February. Q3 results will continue to drive volatility and enable some reshuffling in sectors.

Additionally, one should be watchful of the events surrounding Beijing (China) given that the authorities have initiated mass testing and imposed a strict lockdown after a surge in cases due to the new coronavirus strain. Given the enormous participation from China in global trade, the resurgence of new strain may lead to uncertainty. And markets hate uncertainty!

Investors are advised to remain watchful of these major events and restrain from aggressively chipping in new monies.