Watch out for these 4 big risks that market faces in 2021

In the year 2020, the coronavirus outbreak and subsequent lockdown upended lives and wrecked economies in the early months. In the later part of the year, as restrictions eased, the Indian economy showed signs of recovery, so did the market.

Improved economy and earnings, ample liquidity, central banks' decision to keep interest rates low, vaccine rollout and measures taken by the Reserve Bank of India and the government saw the market rally 15 percent in 2020 to hit record highs.

The year 2021 is expected to be positive as well but these risks stand in the way of the market giving similar returns as 2020:

Coronavirus and the vaccine 

Containing the coronavirus outbreak is the top priority of the government. Unless the virus is contained, it will continue to pose a risk to life and the economy. So far, India’s recovery rate is looking good at more than 96 percent, with a low fatality rate at 1.44 percent. The government is also expected to roll out the vaccine in the coming days.

"First and foremost risk is the attainment of effective and speedy containment of the pandemic, the second wave of it as well as new strains. If it leads us to another shutdown, it will be extremely disastrous," Joseph Thomas, Head of Research at Emkay Wealth Management told Moneycontrol.

The United States, the UK and several other European nations are still reporting higher numbers of cases, as a new and more infectious strain spreads.

Despite the second wave in most of Europe and a third wave in the US, expectations of the vaccine rollout bringing the virus under control have led markets to higher altitudes, Unmesh Kulkarni, Managing Director Senior Advisor at Julius Baer India, said. 

Any development that challenges this premise would be the biggest risk to markets—delay in the vaccine reaching people or the jab not being as effective against the original virus or new strains. “Such an eventuality would prompt nations to again run for shelter through partial lockdowns, etc, which could cause jitters in the stock markets, which are already pricing in a lot of positivity emerging from the vaccine rollout," Kulkarni said.

Harshad Patwardhan, CIO-Equities at Edelweiss AMC, said with successful results from phase 3 trials of many vaccine candidates, the beginning of the end of the outbreak had begun. The global distribution of vaccines remained a challenge, so was the emergence of new strains.

Geo-political events

"On the back of a disastrous year like 2020, next year should be the one of recovery and normalisation. However, one should keep an eye on geopolitical events, given the expected changes in the US policies with the Biden administration taking over," Patwardhan said.

Joe Biden takes oath as the US president on January 20. His policies, reforms, another stimulus and his government’s stance on trade relations with China will be closely watched.

"A risk may be seen from geopolitical factors, centering around China, Iran, North Korea, the US policies in respect of these as well as the approach to the tariff issues with China in particular," Joseph Thomas said.

Inflation, crude and FII flows

Inflation has been rising for several months and with crude oil inching up, prices may remain high. There is a chance that central banks may announce the apartial unwinding of liquidity that lifted emerging markets including India.

"The factor that we need to take cognizance of is the likelihood of persistently higher inflation leading to some central banks initiating partial unwinding of the liquidity already infused into the economy. This may adversely impact the earnings profile as well as valuations over a period of time, especially if it proves to be the beginning of a period of gradual tightening of policy. This assumes greater importance as oil prices seem to be poised to move up, as well as some other commodity prices," Thomas said.

Crude has already crossed $55 a barrel, the highest in last 11 months, pushing up petrol and diesel prices in India.

FII money is always a risk for emerging markets. Indian equities saw more than Rs 1.6 lakh crore of inflow in 2020 (against Rs 89,000 crore in the previous year), which was the key driver of the market’s record run.

"Another major factor that catapulted the markets to such heights was the unprecedented liquidity that was pumped in by the governments and central banks around the world, along with massive rate cuts and loose monetary policy. A large part of this liquidity has gone into financial assets, creating asset bubbles, which the central banks would be keeping an eye on," Kulkarni said.

On the other hand, inflationary expectations were also picking up. India witnessed high CPI inflation for most of the year. “While the Fed has pledged low interest rates for the whole of 2021, a sustained build-up of asset bubbles or growing inflationary expectations could very well prompt the Fed (and/or the RBI) to roll back some of the liquidity measures," he added.

For instance, the Reserve Bank may choose to partially roll back the emergency rate cuts of 2020, sometime in the second half of 2021, Kulkarni said. “This could potentially create volatility in the markets akin to what we witnessed in 2013, with the famous ‘tapering’ of the Fed’s quantitative easing," he said.

A slip in economic, earnings recovery

The expected recovery in earnings and the economy in 2021 seems to have been priced in by the market. If these disappoint, then the market can nosedive.

Most experts expect earnings and economic growth to be in double digits in 2021 against the low base in 2020.

Domestically, "the key monitorables will be the overall recovery in the economic environment and corporate earnings, as the markets have already started pricing in a healthy growth trajectory; hence, any disappointment on the earnings front can pose a risk," Kulkarni said.

A spike in crude prices beyond $70-75 a barrel, too, would weigh on the country's finances and corporate profitability, he said.