Markets are yet to bottom out

In a matter of 46 trading days, from January 20 to March 24, the National Stock Exchange’s Nifty 50 witnessed a decline of 4,919.4 points – from a life-high of 12,430.5 the Nifty 50 tumbled down 39.58% to 7,511.1 points then. But, while the Covid-19 pandemic and the gloom associated with it has ensured that volatility prevailed on the bourses, there has been substantial recovery in the Nifty 50, as well as other broader indices.

Fourteen trading sessions after the markets witnessed the March 24 bloodbath, the Nifty 50, at April 16’s low of 8,821.9 points is higher by 1,310.8 points than the 7,511.1 points – the 52-week low touched on March 24. In percentage terms, the recovery is 17.45%. And, in psychological terms many investors feel that we have touched the bottom, and are now creeping out of the bear zone.

But have we? Really? While the question is more sentimental, the answer has to be logical. And, while analysts have varied views on where they see the Nifty 50 in the coming quarters, what they have in common is the global financial meltdown or the global financial crisis (GFC) of 2008, as the nearest comparable to the current Black Swan event – the Covid-19 pandemic.

In an April 15 report, ICICI Securities’ analysts Vinod Karki and Siddharth Gupta noted that global stock price reactions are indicating a bottom. In the duo’s view, major global equity indices have ‘technically’ entered bull market territory. Because, technically, global equities after falling on an average by 35% (based on closing prices) have bounced back by nearly 19%.

Karki and Gupta flagged the ironical fact that China, despite being the country of Covid-19 origin, is the only global equity market which did not slip into bear market territory. But, top countries to bounce back more than 20% from the recent lows include the US (+ 25%), Germany (+25%), Canada (+ 26%), South Africa (+28%) and South Korea (+25%). “And, (these) are technically bull market movements,” the duo wrote. “Indian equities are yet to rise above the 20% convincingly from their lows (+18% currently).”

Separately, in an April 16 note from Goldman Sachs (Asia), a team of seven Hong Kong-based analysts also highlighted that after falling 38% from its mid-January high; Nifty 50 has bounced back almost 20% from its March lows, along with a rally in the rest of the region and broader equity markets globally. “The rally over the past three weeks has prompted investor queries on whether markets have bottomed and could we see a sustainable recovery rally,” they wrote. “We think not.”

The Goldman Sachs analysts view the current rally as a bear market rally, which are common in history. “As an example, in India, Nifty (50) experienced four distinct rallies ranging from 12%-25% in 2008 within an overall bear market with 60% peak-to-trough decline,” the analysts wrote. For markets to make a lasting bottom, they have been monitoring a set of conditions that include flattening infection curves, visibility on the depth and duration of economic disruptions, sufficiently large policy stimulus and deep undervaluation of assets and position reduction.

Referring the views of Goldman Sachs’ global macro strategists, the seven analysts opine that the global equity rally in recent weeks has been driven by reduced “left tail” risks in the global economy and financial markets. “These include signs of flattening infection rate curves across major DM (developed market) economies coupled with unprecedented monetary and fiscal support,” they note.

While global tail risks may have reduced, the analysts see significant domestic risks in India. Among these risks, the spread of the virus has escalated sharply in recent weeks. Also, the extension of the nationwide lockdown for another 3 weeks (until May 3) and social distancing measures are likely to cause significant contraction in economic activity.

Furthermore, the fiscal easing in India has been limited so far compared to many of the other regional and global economies. Although Goldman Sachs’ economists, who forecast India’s FY21 GDP at 1.6%, expect more easing. Basis the GDP projection, the analysts expect corporate profits to decline by an annual 13% in calendar year (CY) 2020, before seeing a 23% recovery in CY2021 as the economy recovers.

While consensus on the earnings per share (EPS) growth forecast of stands at upwards of 15% for CY2020, these analysts expect further substantial negative revisions, as markets head into the 1Q-CY2020 (quarter-ended March 2020) earnings reporting season. “With a likely steep fall in earnings estimates and market valuations still looking optimistic, it seems too early to assert that equity markets in India have discounted all the negatives,” they add.

In their view, while markets may not retest fresh lows given reduced global risks, they do believe that Indian equities are likely to relatively lag the region on expectations of a slower recovery. “However, more forceful policy support could help recovery and pose upside risk to markets.”

Fundamentally, the Goldman Sachs’ analysts highlight the uncertainty about near-term earnings, and that of P/E (price to earnings) multiples using perfect EPS foresight, CY2021 EPS remain well above previous crisis levels. Also, the trailing P/B (price to book ratio) at 2.2 times is about 15% above the trough of 1.9 times in the GFC.

However, foreign ownership of Indian stocks remains elevated with foreign portfolio investors (FPIs) having sold equities worth $10 billion, which works out to 0.4% of the total listed market capitalisation, as against $15 billion worth of outflow, which was 2.3% of the total, back in the gloomy GFC days. Basis these factors, the Goldman Sachs analysts lowered India to ‘marketweight’ within Asia on delayed recovery and extended valuations with a Nifty 50 target of 9,600 by June 2021.

On the other hand, while ICICI Securities’ Karki and Gupta do not ascribe any target number to the indices, they highlight that, internationally, the forward looking behavior of equities and pro-active policy making is driving the rally. For instance, normalisation of Covid-19 situation in China, and flattening of curve in worst affected areas such as Europe (+39% weekly growth) and USA (+71%) are allowing markets to look beyond the short term.

In case of India though, the weekly growth rate at 125% is higher, as extensive testing kicks in. However, the duo also highlights that India’s Covid-19 positive to tested ratio and death ratio are among the lowest globally.

Like Goldman Sachs’ analysts, the ICICI Securities’ too draw a comparison with GFC. “Unprecedented and pro-active stimulus from policy makers dwarfs the lagged reaction during GFC,” Karki and Gupta noted. The duo quote the example of US fiscal stimulus in 2009, of around $800 billion, which in their view was ‘reactive’, as compared to the current ‘proactive’ $2.3 trillion already announced.

“Similarly, monetary stimulus has been much quicker and larger in the current environment,” the duo note further. Earlier, in mid-October last year, ICICI Securities had articulated that current stock price movement is a better predictor of upcoming GDP (2 – 3 quarters later) than the other way around. “As per the latest IMF (International Monetary Fund) estimates, global GDP, after falling 3% in CY20, is expected to bounce back in FY21 with a growth rate of 5.8%,” Karki and Gupta added.

Karki and Gupta are also of the view that India’s relative strength lies in its net oil importer status, above average growth, and above average RoE (return on equity) while forward P/E dips to global average. Due to the sharp correction, India’s forward P/E of around 14 times is at global average, while the RoE profile of 14% and broader economy growth expectations are above average. “Sharp correction in oil price is a positive for India’s external sector,” the duo adds.

However, the key risks in the duo’s view include the continued uncertainty around Covid-19 as situation is still evolving. “Despite the flattening of the curve in various geographies, the Covid-19 related situation is still evolving with behavior post removal of lockdown unclear, which could continue to create volatility in financial markets,” the duo note.

Earlier, in an April 10 note, Dhirendra Tiwari and Pankaj Chhaochharia, both analysts with Antique Stock Broking wrote that they believe that volatility will persist as we are not yet out of the pandemic woods. “Fear can only be allayed by vaccine, drug discovery, flattening of new cases and lifting of the lock-down,” Tiwari and Chhaochharia wrote, highlighting that around 30% of world population was currently under lockdown.

The duo, like their peers at Goldman Sachs and ICICI Securities, also touched upon the GFC, and cautioned that they expected FPI equity outflows of around $35 billion on the assumption that the 2008 panic prevails. It is noteworthy that India has already witnessed FPI equity outflows of around $10 billion. If that is accompanied with lack of SIP (systematic investment plan) equity inflows, then the Nifty 50 could be lead to test sub-7,000 levels in short term, the duo opine.

In Tiwari and Chhaochharia’s view, India may suffer a direct economic impact of around $100 billion over Q4-FY20 and Q1-FY21, due to the 3-week of total shutdown. The lockdown extension, up to May 3, which was announced on April 14, would add further pressure on the economy. On the markets’ movements, basis scenario analysis, the duo arrived at Nifty 50 EPS and target levels as all estimates are heavily contingent upon the spread, depth and duration of the Covid-19 pandemic.

In their base case scenario (assuming Covid-19 impact till September 2020), the duo has downgraded FY21/FY22 earnings by 16.9%/ 14.4%, and accordingly, their revised Nifty 50 target price stands at 9,900. The duo cautiously believe that as Covid-19 spread has not yet peaked in India, their bear case scenario may also play out and hence Nifty 50 may see further correction to 7,000.

“With things getting worse day by day, probability assigned to bull case has been continuously falling and bear case scenario is gaining strength,” the duo noted. For the record, Tiwari and Chhaochharia assigned 10% probability to the bull case, where they assume two quarter impact, till June 2020. If that does happen, their Nifty 50 target stands 12,800.

While their base case, with 60% probability, assumes three quarter impact till September 2020, and Nifty 50 around 9,900. The duo’s bear case, which carries 30% probability, assumes impact over four quarters till December 2020 quarter or beyond, and accordingly Nifty 50 at around 7,700.

Tiwari and Chhaochharia rightly highlight that reasons for every economic meltdown have always been different, but there are similarities with all past meltdown. The problems are usually global in nature, where India has a second order impact, which is accompanied by some domestic issues.

The later largely leave the domestic economy to struggle for the next 4-5 years. “But equity markets rebounds rather quickly when the probable remedy emerges (in the current case it is a medical cure),” the duo added.

The most important thing to note about India is the fact that unlike in the past, the current black swan event happened when the economy was already slowing down. “So we fear that the economic recovery may take some time,” Tiwari and Chhaochharia added.

The duo affirms that with fear at its peak across the world, valuations look extremely attractive. These times are best suited for value or contrarian investing, they opine. Though cliché, the duo chose to quote: "Be fearful when others are greedy, and greedy when others are fearful". The time is not apt to leave the guard down, as the markets have not yet bottomed.

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