Something strange happened since March 23 in the Indian stock market. As the national lockdown started, the entire domestic economy came to a standstill. Contrary to this, the market benchmark BSE Sensex started moving up. This was inexplicable. It was as if the investors, who were buying, were determined not to let the market fall further, after it slipped below the psychological 26,000-mark. They believed they have had enough. February month was bad for equities, as Sensex fell 5.9 per cent in a sell-off, which was initially related to disappointments to the Union Budget-2020. March was witness to a different kind of selling.
By March 23, the index fell 32 per cent in 15 trading sessions of that month. The coronavirus cases had started picking up, first in tens, then fifties and hundreds. But since the Sensex dipped below 26,000-level, it was as if the equity market participants, led by domestic institutions, were ready to prove that coronavirus disease outbreak was not as bad as it was made out to be. Poor economic growth? You are over-thinking. Job losses? Don’t be a scare-monger. Covid-19 crisis? Spanish flu was worse. Every risk highlighted was met with sly responses, downplaying the virus which was going ‘viral’. When India went for the first national lockdown beginning March 25, there were about 600 total cases. By May 8, that number has crossed 59,000. Yet, the BSE Sensex has galloped over 21 per cent in this period.
There are two sides to every story. The bullish investors believe the selling was over-done in domestic market. They say the worst has already been priced in. They say a cure may be round the corner. In short, they are pitching ‘hope’. On the other hand, bears say numbers speak for themselves. From daily hundreds of cases being reported, today thousands of cases are being reported officially. Most agencies project 0% GDP growth for India in 2020-21 financial year. The debt market is worried sick and illiquid, with investors money worth Rs 26,000 crore stuck in one prominent fund-house that has decided to wind up six debt schemes. Are Indian markets up too much, too soon?
Bear Market Rally
If you remember what happened in the global financial crisis 2008-09 in the Indian market, you will recall that markets did not fall 50 per cent in a straight line. There were a minimum four bear market rallies ever since January 2008. Every time, the market fell, it made a new bottom, then it rallied and then made a new bottom. The first correction saw 22 per cent drop, then a rally. Then, again the second correction saw 18 per cent drop, then a rally. The, again the third correction saw a decline of 27 per cent and again a rally. The 4th phase of correction was brutal with 45 per cent drop, making the absolute bottom. Then, a rally happened and market remained flat for 5-6 months. This is not unique for GFC.
“We have witnessed three to four waves of corrections (followed by rallies) in other major market downturns as well -- like 2000 dot-com crash, 2011 European debt crisis, etc.,” says Bajaj Allianz Life Insurance’s Global Macros, Markets, Stimulus & Coronavirus (Covid-19) Impact report.
Why are we talking about 2000, 2008-09, 2011 market behaviour? Because, market can make you forget inconvenient truths. In 2020, the stock market has barely seen one and half round of correction. Equity marketing teams are already calling it ‘the bottom’. But do they have any concrete evidence? Those, who feel the Indian market is past its worst, point to 3 arguments that we have enumerated below.
* A Cure Is Round The Corner - Biotechnology companies around the world are going head-to-head to find the vaccine. The Oxford vaccine and the Chinese vaccine are said to be in advanced stages. Israel has claimed that it has achieved a ‘significant breakthrough’ in developing an antibody to the coronavirus and applied for a patent. Italy has also announced that it has developed a vaccine for the virus that could effectively work on humans. Remdesivir, biotech giant Gilead’s experimental antiviral drug, has been given Food and Drug Administration (FDA) emergency authorization to treat certain Covid-19 patients. Even, The Japanese Ministry of Health, Labour and Welfare (MHLW) has granted regulatory approval to Veklury (remdesivir) as treatment for SARS-CoV-2 infection under an exceptional approval pathway. A proper vaccine or cure is still months away, and what happens in the intermediate period is what will drive the narrative.
* India Still Doing Well - The investors, who think market sits on a solid platform, argue that India is doing well despite its 130-crore population. They argue 59,000 confirmed cases makes India 14th/15th in global Covid-19 list. Similarly, mortality cases are less than 2,000 (deaths so far). India has so far conducted 15 lakh sample tests and based on that we have 59,000 cases i.e. four per cent are affected. America, which has reported over 13 lakh cases, has done 24 tests per 1,000 people. In comparison, India has done first test per 1,000 people. As and when India does more tests, more cases should emerge. In fact, states in India that have done more tests have reported more cases. For instance, Maharashtra, which has over 19,000 cases, has done over two lakh tests. The 2nd worst-affected state Guajarat has done over one lakh tests and reported nearly 7,800 cases.
* Govt Response Has Been Good - Bulls say that Indian government has been swift in terms of announcing policy measures. The lockdown itself is a big policy response. In fact, the lockdown was one of the strictest enacted globally. However, the lockdown has an ugly side. All economic activity barring essential services came to a halt. Transport services came to standstill, leaving people stranded wherever they were. The RBI responded by cutting interest rates by 0.75 per cent. Key interest rate benchmark repo rate stood at 4.4 per cent, lowest in recent history. CRR limit, requirement of cash to be parked by banks with RBI was reduced by one per cent, boosting liquidity in the system. RBI also announced LTRO (long term repo operations). The government announced fiscal measures of Rs 1.7 trillion equivalent to 0.8 per cent of GDP. Some restrictions have been eased in places not much affected, but along the way the epidemic has moved from health problem to economic and societal and also a humanitarian crisis.
The reward-risk balance for the Indian market has become less favorable following the sharp run-up in stock prices over the past 3-4 weeks. “The price-value gap has closed in some stocks and is less clear in others given large economic and earnings uncertainty. The market is factoring in some combination of (1) Covid-19 pandemic being not as bad as initially feared and (2) Covid-19 impact being quite bad for the economy and corporate earnings (despite sharp downgrades),” says Kotak Institutional Equities Research.
As per the Kotak research outfit, the sharp run-up in stock prices over the past few weeks has reduced the options among the six broad investment buckets for the Indian market—(1) consumption (staples, discretionary), (2) financials, (3) investment, (4) outsourcing (IT, pharmaceuticals), (5) utilities and (6) commodities (domestic, global).
“We see (1) little value in most consumer staples and pharmaceuticals stocks now after the recent sharp run-up in their prices, (2) severe demand issues in consumer discretionary (large-ticket) and investment sectors and (3) potential large credit risks in financials, which reduces investment options,” it added.
Earnings Picture Still Unclear
The ongoing results season for listed companies in India is with regards to January to March 2020 quarter. In a sense, this doesn’t capture much of the lockdown effect. The whole picture will be revealed in the April to June quarter earnings, which will come only in July 2020. But the March quarter 2020 results do point to a somewhat irrational expectation from Indian equities. It’s not the small companies that have failed to meet lofty expectations. In fact, the biggest firms have not delivered as much as expected. According to a research, many companies were carrying the burden of heightened expectations and they simply didn’t deliver.
The Q4 bottomline growth estimates for AU Small Finance Bank was five per cent growth, but the actual number was down 40 per cent -- mainly dragged down by provisions toward Covid-19 and higher other opex. HUVR saw 7%/2% YoY volume/PAT decline in 4QFY20 (despite a trend run rate till mid March 2020).
“Hindustan Unilever (HUVR) performance was subdued and below our and consensus estimates on key headline numbers,” says Axis Securities. As per YES Securities, SBI Life Insurance’s Q4 FY20 APE (annual premium equivalent) at Rs 26.9 billion was weaker than estimates of Rs 27.5 billion, APE declined by 13.2 per cent YoY. Tech Mahindra’s 4QFY20 results were below expectations on USD revenues and EBIT margin, according to Centrum Broking.
The actual economic effect due to Covid-19 on companies will be pretty bad. Crisil has revised its growth outlook for India in fiscal 2021 down to 1.8 per cent, from the 3.5 per cent estimated earlier, factoring the nationwide lockdown to stem the Covid-19 pandemic. The forecast assumes the effect of the pandemic subsiding materially in the current quarter, besides a normal monsoon, and minimum fiscal support of Rs 3.5 lakh crore. Crisil admits risks to its India forecast are tilted to the downside, manifestation of which could take GDP growth to even zero. Says Dharmakirti Joshi, Chief Economist, Crisil, “we see a permanent loss of ~4% of GDP. Fiscal 2022 is likely to see a V-shaped recovery at over seven per cent real GDP growth. But even assuming growth sustains at this level for the next three years, real GDP will stay below its pre-Covid-19 trend path.”
A Crisil Research analysis of over 40,000 companies with employee cost of Rs 12 lakh crore indicates that about 52 per cent of the employee cost is incurred by companies in sectors that will see material increase in stress in case of extended lockdown. The sharp deceleration in growth and increased income uncertainty is certain to pull demand down. Says Prasad Koparkar, senior director and head (growth, innovation and excellence hub), Crisil, “as India Inc stares at a double-digit slide in revenue this fiscal, the worst in at least a decade, EBITDA is set to fall sharply – by over 15 per cent – in our base case scenario of 1.8 per cent GDP growth. The adverse impact of operating leverage due to sharp revenue decline will drown all the benefits accruing from lower material and energy costs following across-the-board decline in commodities.”
Just A Bounce or Rebound
A global recession on the cards, and a sharp growth slowdown in India as well this year—depending on how long the lockdown lasts. For many professional forecasters, the situation is proving to be difficult as the exact impact on corporate earnings growth (as it’s a developing situation) is impossible to estimate. What they are sure of is a significant downward revision in earnings going forward.
Risk-reward for equities are still quite favourable, despite the recent rally. Mid-cap stocks are trading at a healthy discount to large-caps. But this situation is not given to last long. The market has a mood of its own. Many new investors in the stock market in this period are inexperienced. They want a quick entry and a quick exit. But as Warren Buffett says: “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.” This statement holds true for the Indian market.
The RBI and a section in the financial sector believe interest rate cuts can change the economic outlook. But it is yet to be proven whether interest rate cuts, we have seen many of them, can actually turnaround the Indian economy. Of course, the stock market gets excited with every rate cut. Goldman Sachs Economics Research is anticipating a cumulative 100 basis point rate cut.
“We now expect the RBI to reduce the policy rates by 100 bps between now and the end of Q3 (compared with our earlier expectation of 50 bps; markets pricing in 50-75 bps of rate cuts over the next six months). This is due to three main reasons: First, we recently revised our India FY21 GDP forecasts significantly to -0.4% (vs Consensus Economics median 2.7%) following the extension of the nationwide lockdown. Second, despite some temporary pressures starting to show up in higher food prices due to supply bottlenecks, we expect headline inflation to come down. Third, the RBI’s forward guidance provided during the last MPC press conference - where the MPC unanimously decided to continue with an accommodative stance as long as necessary to revive growth - suggests space for further cuts,” Goldman experts Prachi Mishra and Andrew Tilton wrote in a report dated May 7.
Not every market expert is ready to become a full optimist. “We are not fully convinced of the durability of current market up-move and believe that street has not fully factored in the impact of CoVid-19 induced lockdown. March 2020 volume/earnings disappointment from large index stocks such as HUVR, RIL and rising Covid-19 provisioning for banks are precursors to greater systemic earnings weakness in coming months,” argues Varun Lohchab, head (institutional research), HDFC Securities.
Varun points out that RBI’s rate cut/liquidity measures are not percolating into the system as intended while fiscal measures have been delayed and underwhelming. “We would deem recent market surge more as a bear market rally and not a resumption of bull market. Proactive and co-ordinated moves of global central bankers and governments have helped mend financial market sentiments, but the impact on real economy and corporate earnings seem to be underestimated after current rally, in our view,” he signs off.
It must be remember that banks/financials are the main leg of the Indian stock market today. And, this leg is weakening. “In the wake of historic output loss followed by potentially a prolonged (long bottom) economic recovery during FY21-22, we further downgrade our (banks) sector view. We now move closer to a stress case scenario in FY21-22 as we expect the current economic situation will drive paradigm changes in the sector in the near to medium term. More than just the growth slowdown, we are now on the verge of a new (and unique) NPA (non-performing asset) cycle panning across corp/retail segments lasting through at least FY21-22. In our view, this will drive sector RoEs (Return on Equity) closer to cyclical lows and also raise cash call risk for most banks over the next 12-18 months. We will likely see liability consolidators (led by HDFC Bank, Kotak, SBI) emerge stronger over the medium term, but until the current NPA cycle peaks, we see downside risks to valuation multiples,” says BoFA Securities.
The writer is a journalist with 14 years of experience