The Indian capital markets have been through a tumultuous journey over the last three months. Initially in March, markets were gripped with the fear of the unknown and the associated uncertainty (Nifty fell 38% from its high in January), stemming from the virus-led intense anxiety invading people’s lives and crippling the larger society and world economy.

Then came the hope rally in April (Nifty up 14.7%), with several announcements of initiatives towards discovering the much-coveted vaccine and the avalanche of liquidity infusion/stimulus with trillions of dollars committed by central banks and governments across the globe, with the U.S. at the forefront. Global markets could not have asked for more, and they staged one of the smartest comebacks through April and May, with the S&P 500 (U.S.) up an impressive 43% from the March 23rd low, and the Nasdaq 100 even turning positive and returning 10% for the calendar year thus far.

However, the journey of Indian markets was different initially, with the Nifty under-performing global markets through the fall and the rebound, given the prevailing weak economic environment and the government stimulus probably falling short of the elevated market expectations. However, the markets seem to be catching up now, with the Nifty recently rallying by 15% in a little over two weeks, resulting in a clear ‘left-out’ feeling amongst market participants.

So what’s cooking? And where is this sudden optimism coming from?

The ground realities

In India, the Covid-19 situation does not inspire any confidence, as yet. Confirmed cases are much on the rise, creating new highs in daily reported numbers. India has in fact rapidly progressed up the Covid-19 ladder to reach the fifth place from the top. Additionally, the first unlocking announced recently could bring about a spike in cases in many parts of the country that have been trying to contain the spread.

Countries that have already flattened their Covid-19 curves have started fearing a second wave.

The five severe lockdowns in India have paralysed the economy, and the GDP is expected to contract 4% to 6% in FY21, according to various market estimates.

Several parts of the economy are already contending with tough times ahead, especially the service sectors (airlines, hospitality, travel & tourism), real estate, consumer discretionary spend (particularly higher ticket) due to falling incomes and potential job losses, and above all, the banking/financial sector, with the possibility of rising defaults by corporates/MSMEs and delinquencies among retail borrowers.

The recent migration of the ‘migrant’ workers to their home states has further accentuated problems for the manufacturing and construction industries due to uncertainties around their return to work and the consequent labor shortage.

Any hopes of a handsome fiscal stimulus to support the ailing parts of the economy were dashed, with the Government preferring to go the frugal path and announcing a very modest actual fiscal support from within its INR 20 trillion package, given the tight fiscal situation.

Moody’s has downgraded India’s sovereign rating recently to Baa3, the lowest investment grade rating, citing challenges with respect to a fragile fiscal position and a sustained period of low growth.

In other words, sooner or later, markets will have to brace for a sharp drop in earnings of a large set of companies operating in a variety of sectors. Needless to say, the impairment this time around is far more severe as compared to the GST and demonetisation pangs.

Despite the dark clouds on the horizon, the equity markets have been showing a fair bit of buoyancy. Where lies the silver lining?

Markets were looking out for some sign of initiation of economic activity after 2.5 months of lockdown, and it has arrived in the form of Unlock 1.0, with several relaxations across the country for traders, shopkeepers, manufacturing and some services, and part-resumption of airline operations. A clear sign that the country is taking baby steps towards restoring its human and economic activity.

The recent market rally across the world, and especially the US, has been largely driven by global liquidity – rate cuts and large fiscal stimuli (direct and indirect benefits) by several central banks and governments across the globe – as well as news-flow around development of vaccine and virus-mitigating drugs. While the latter is more of a ‘hope’ factor as of now, the massive liquidity has certainly propped up investor sentiment, especially for companies with sound business models and strong balance sheets (e.g., technology, internet companies and healthcare in the US).

The Indian markets, after initially shrugging off the US market rally, have finally responded with a much-awaited catch-up rally. Foreign portfolio investors (FPIs), that were big sellers of Indian equities through March and April, turned aggressive buyers in May and early June.

The massive global as well as local liquidity ensured smooth absorption of billions of dollar supply of quality equity stocks such as HUL (selling by GSK), stake sale by Bharti promoters, Standard Life and HDFC selling stake in HDFC Life, Kotak Bank QIP and subsequent stake sale by the promoter. Besides the flurry of investments in Reliance Jio platform by global companies and private equity players (₹ 1 lakh crore, and still counting) as well as a strong response to the Reliance rights issue (₹ 50,000 crore) are clearly indicative of the strong liquidity momentum.

Markets are sensing opportunities

While there will be structural issues for many companies and sectors, markets are certainly sensing opportunities in certain sectors that will be less impaired or may even see some growth – ‘Corona-proof’ sectors such as pharma/healthcare, telecom, chemicals, some parts of IT, consumer staples and parts of the rural economy. And the government’s announcements for the MSME segment and NBFCs will, to a certain extent, assuage the pain currently faced by these two critical segments of the industry.

Some value-buying has also surfaced in ‘Corona-prone’ sectors, as seen in the recent rebound in auto, metals and even banking/financials, despite the dark clouds looming over these sectors. The private equity deal news-flow in the telecom sector has been a big booster for the decimated sector.

So what’s the road ahead?

Markets, in a way, have written off CY 2020, and are now looking at pockets of revival and opportunities in CY 2021. As the current Unlock 1.0 progressively extends into Unlock 2.0, 3.0 and so on over the next few weeks, there will be a clearer direction for markets with respect to the opening up of the economy and the extent and pace of the recovery.

Global economy likely to rebound in 2HCY2020

Globally, the broad-based policy response and declining Covid-19 curves point to earnings recovery ahead; equity markets will typically bottom before earnings trough. With several countries now starting to unlock their economies, the global economic recovery is likely to commence in 2HCY2020, restoring GDP levels in China until end 2020, in the US by 2021 and the Eurozone by end 2022. The US is clearly likely to lead the earnings recovery, given its stronger policy response and the increasing growth divergence post-Covid-19.

Home markets likely to witness consolidation

Back home, it is likely that markets will see some consolidation in the near term after the recent sharp pullback, and operate within a broad trading range thereafter. Markets will have to balance out the hard ground reality of GDP contraction and impending earnings cuts with the optimism arising from the progressive “Unlocks”, global liquidity, medicine news-flow and emerging value within stocks and sectors. It is becoming increasingly apparent that the March 23 bottom is now firmly in place and unlikely to be tested again, especially as the unlocking has already commenced, unless a major second global wave emerges, forcing countries to go back into their shells.

Sowing seeds for the next phase of growth

While the government’s economic package did not dole out any major cash stimulus, the structural reforms, focus on self-reliance (Atma Nirbhar Bharat) and removal of several bottlenecks, along with the RBI’s rate cuts and liquidity support to the financial system will however sow the seeds and pave the way for the next phase of growth and market cycle. The current phase of the markets therefore provides investors sufficient time to re-align their portfolios, and investors should certainly use intermittent market corrections to build-up their equity allocation within the confines of their strategic asset allocation.

The tunnel may be a bit dark and long, but it certainly leads to a brighter 2021, with several parts of the globe emerging from the darkness and rebounding to their potential growth.

Views are personal.

The author is MD - Julius Baer India.

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