After the brutal selloff in March we saw the markets staging a strong pullback in April to finally give up a large part of the gains in May. The Indian Market behaviour is not in line with a majority of other markets where the selloff has not been so severe. India is one of the worst performing major equity markets in the world today. This is not without reason.
The economic outlook throughout the world has continued to deteriorate as the Covid Crisis has played out and created disruptions much beyond what most thought of a few weeks back. The daily no of cases worldwide have not peaked out with the overall global numbers still growing although there has been a huge redistribution of cases away from the earlier hotbed European countries of Italy, Spain etc to the USA, Brazil, Russia, India etc where cases still continue to grow. Most economies still continue to operate at suboptimal levels with forecasts now indicating a 5-15% decline in GDP for most countries this year. Some Oil dominated countries are likely to see a much severe downturn given the way oil prices have collapsed.
The Global response to the Pandemic has been aggressive monetary and fiscal stimuluses across the board in most major economies. The USA, Japan, UK etc has been at the forefront of the aggressive moves. The US Federal reserve has gone all out in terms of stabilizing the markets, growing its balance sheet and provided global liquidity. Fiscal stimuluses in many countries have been quite substantial so that even with the unemployment benefits most businesses can survive for a few months. This has stabilized global markets and infact the Nasdaq is now higher for the year driven by technology companies that should benefit due to shifts of businesses and consumption due to the pandemic as well as biotech firms. There is also a global reallocation of money from bonds to equities given the crash in bond yields and equities are getting a yield support. However the V Shaped recovery in the markets is excessive at this stage in my view as the real impact is quite severe. Emerging Markets in general have underperformed.
The response of the Indian authorities has been mixed. The RBI has responded very well to the crisis and has pushed out huge liquidity, cut rates aggressively and Via LTRO’s tried to stabilize the bond markets. The latest move was yesterday. Extending the loan moratoriums to August and allowing working capital interest till August to be capitalized and paid over the next 7 months also alleviates near term cash flow stresses. However this crisis is not only a liquidity crisis but also a Solvency Crisis which is the bigger fear today.
The response of the government is lacking in most ways. They have given out no real support to businesses, individuals etc. If taken in combination with the excise duty hikes on petrol and diesel the actual Fiscal Stimulus is virtually nothing. Almost the entire Rs 20 Lakh package is just easier access to finance and no real stimulus. Job losses are huge, business closures are picking up especially small businesses and salary cuts are growing. This will lead to slower consumption demand growth going forward. Investment demand is also likely to be subdued given the fact that there is now excess capacity with most businesses and government finances are so strained that we are likely to see a big cut in Capital Investment by both the Central and State Governments.
The focus of the government continues to be trying to please the rating agencies and controlling the Fiscal Deficit. However Fiscal Deficit has two components, the gap between revenues and expenditure on the top and GDP at the bottom. So if GDP is compressed even if the top of the formula remains constant the Fiscal Deficit will grow. Here we are going to see both the top gap of revenues to expenditure will grow and GDP will compress. The only way out is to grow the GDP aggressively after the crisis is over. This might not happen as it requires a real fiscal stimulus in the form of income supports, income tax rate cuts, GST Rate cuts etc or a combination of all of them which the government under advise of Arm Chair Economists doesn’t want to do. This creates a peculiar situation for India where from a country which due to lesser no of infection spread due to the severe lockdown could have benefited from the crisis is unlikely to see any major benefit.
The Global Markets have also largely ignored the growing tensions between the USA and China where both rhetoric and actual action from the US side is growing every day. China’s moves to impose new laws in Hong Kong amidst the crisis will also increases these tensions. All of us know how growing tensions created market selloffs in the years 2018 and 2019. With US Markets now stretched in terms of the way they have moved this could create a sudden and swift selloff which everyone should be ready for.
The results season is now on in India. As I attend more and more conference calls what is very clear that most companies have no visibility of growth at this stage as they are unclear on the direction of growth post lockdown. Every company is just cutting costs, trying to optimize supply chains and support their dealers etc and the entire chain. There is also a concern about what social distancing will do to efficiency levels of manufacturing as well as sales in the near term. There could be cost increases which might be tough to pass on to the customers.
The migrants issue is also becoming big now with the economies of both the host states as well as the states of origin likely to see a hit on their economies. The returns of crores of migrants will make the return to normalcy a slow process as many factories, construction projects and other businesses face labour shortages. Most of these people remit money to their families and as such the economy of the states where the migrants are returning will also suffer. Economies of states like Kerala which received large gulf remittances will also suffer significantly.
In conclusion if we combine the performance of the Economy and the Stock Markets there is a clear disconnect. Remember, unlike the USA where they entered into the crisis at record low unemployment and strong growth we already had anaemic growth for years with high unemployment and a very slow capital expenditure cycle. With the Government largely ignoring the crisis except for the health issue we could see the slow growth prolong for a long time. The only positive at this stage is that agricultural production has been strong thus supporting rural incomes. Monetary Policy also works in India as lending rates in India have been quite high over the last few years. With borrowing costs coming down we will see them support the underlying growth at the margin. With risk free rates coming down the base case valuation for the markets also go up as the required returns from risky investments reduce. Stable businesses with high dividend yield could see the stocks outperform.
Overall as against assumptions of a 15-20% earning growth for 2020-21 we are actually likely to see a 15-20% decline in earnings. Even at an optimistic NIFTY Earning Per Share assumption of Rs 400 for this year (very optimistic) the valuations at a 9000 nifty are around 23X earnings which is high. However the probability of a sharp bounce back of earnings next year is a very real assumption and will provide downside support. My base case assumption will be for another 8-10% Market decline before value emerges. This should happen over the next few weeks. The festival season in September and October will see pent up demand play out and we will see opportunities before that.