The ultra-low interest rates and lose monetary policies across the globe have boosted equity markets for the past one year. However, the honeymoon period for the stock markets seems to be nearing an end.
A report by Kotak Institutional Equities noted that that global central banks will have to start preparing to exit the extraordinary amounts of stimulus as economies gather steam over the next few months. The pace of 'tapering' -- reduction in asset purchase -- and rate increases by central banks will depend on inflation.
"Equity markets will have to adjust to the reality of higher interest rates as central banks start to execute their 'exit' plans for their ultra-loose monetary policies over the next few months," it said.
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Although the Indian market is expected to bring modest returns in case of strong economic recovery, they could see a meaningful correction in the event of a sudden and sharp spike in bond yields linked to negative surprises on inflation.
It noted that there two possible scenarios for the Indian market over the next few months, with base-case scenario of strong earnings growth and gradual increase in bond yields. The other scenario is of low-probability but would have a high-impact of strong growth but sudden and sharp spike in bond yields linked to negative inflation surprises.
Global and domestic bond markets have been quiet for the past few weeks but the probability of faster 'tapering' by the US Fed has increased with recent economic data.
"We see some headwinds to the market given (1) full valuations across most sectors, (2) limited scope of earnings upgrades given extant high expectations for FY2022 (31 per cent growth in net profits of the Nifty-50 Index) and (3) likely increase in global and domestic bond yields," it said.
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The Nifty-50 Index is trading at 22.1X FY2022E 'EPS' (earnings per share) and 19.4X FY2023E 'EPS', which would suggest the market is already pricing in strong earnings growth and stable/moderately higher bond yields, it added.
