The long cycle of the market is intact, though we cannot neglect a sense of volatility in the short to medium-term due to the risk of resurgence in infection in the future and a good amount of optimism built in the market about a re-opened economy. The second wave of infection, though initial reports are weak, may slow-down the strength of the recovery and damage some sectors trapped under the social distancing norm increasing the risk of insolvencies. The recent bounce of the market inclined valuation while outlook continues to be weak for 2020. In the near-term, the market may be range-bound with mixed bias. Accumulation (SIP type investment), is the best strategy for direct equity and MFs to take advantage of this volatility in prices, in the short to medium-term. The economy will flourish since the financial market has been boosted with a high amount of liquidity, the announcement of more supportive measures in the future, and eagerness to move-on with an open economy. A caveat is this direction can completely change to a super gain or loss as per the development of vaccination and drugs, which the market is hoping positively by 1H2021.
Near-term market may be range-bound with mild bias…
In April – May, the markets were in the range of 8,500 to 9,500 for Nifty 50, which during May – June was upgraded to 9,500 to 10,500, with a high of 10,300. This new range is likely to stay with a mixed bias and 9,500 as strong support. If broken,9,000 will be the next strong support for the market. Some points of concern are; a risk-off strategy of FIIsdue to the weak outlook provided by US FED, the risk of insolvencies, the second wave of infection, and the border skirmishes with China.
FII’s net-inflows grew strongly from the highest selling of –Rs65,000cr in March to –Rs5000cr in April and positive Rs14,000cr in May. FII inflows have improved post the correction, stimulus, and re-opening of the economy. Inflow for June had started more vibrantly but turned negative from the second week. As of 18th June, the net inflow was low at Rs8000cr.
The risk of insolvencies has reduced
Due to the Covid-19 crisis, there was a high risk of insolvencies in the financial and other sectors if the economy is imbalanced for one to three years. Post the huge financial stimulus and new norms of working, the risk of imbalance due to loss of revenue and high debt has reduced. US FED and ECB have given hope to the global equity market. FED increased bank reserves from $4 trillion to $7 trillion in a short period of time, and the government announced a fiscal stimulus of $500 billion. The total stimulus is more than the forecasted GDP of India of Rs200trillion for FY21E. Financial packages have also been provided in the UK, European Union, and Japan, respectively. This created a huge amount of liquidity in the financial market and reduced the risk of insolvencies.
The trend may turn cautious in the short-term
FII’s inflow is one of the important reasons for the bounce in the Indian market. They may shift back to dollar funds due to buying support announced by FED and others. A change in strategy from risk-on to risk-off may shift money from EMs equity to less risky US private debt instruments, which are now guaranteed by the government.
The rally was also supported by cheap valuation in the market, which went back to a seven-year low, that too in a span of just a few months. For example, the valuation in India for Nifty50 on a trailing basis fell from 26.5x in February to 14x-15x in April (seven-year low was about 14x), currently it stands at around 21x. The panic that was created in the market was due to the assumption that the economy may be closed for an extended period of time and the pandemic will lead to chaos in the economy. Now there is a consensus that we will have to live with the virus and grow the economy.
India is trying to catch-up with the world…
India was among the worst-hit equity market due to the complete stoppage of domestic economy, a risk-off strategy of FIIs, and a continuous rise in infection. The domestic stimulus announced is not pro-business as in developed markets. The banking sector was hugely hit in anticipation of rising NPAs.
Post the huge correction which took valuation near-decade low, India is trying to catch up with the rest of the world after factoring in all the merits and demerits of the stimulus and in anticipation of a re-opened economy from Q2. There is also an expectation of more reforms that will help the corporate sector. India may not be able to completely follow the developed economies and completely open the economy but we can expect a strong rebound in the economy in H2FY21. India will do well in the long-term since the world wants to diversify its outsourcing from China and move to other emerging countries like India. Economists and experts are forecasting a contraction in FY21 GDP in a range of 2.5% to as high as 10%. At the same time, they are also expecting a stronger recovery and expansion in FY22 in the range of 5% to 8.5%.
The Indian market has done well in the last two and a half months. It may consolidate at the current level with a mixed bias evaluating the international and domestic developments. The extent and type of consolidation may be deeper in a short-period or just marginally tepid in a pressing time of few weeks. We expect the boarder market to be range-bound in which the main indices like Nifty50 to trade within a bracket of 1000 points, as mentioned earlier.
In India, an important factor will be the border skirmishes between India and China, about which, the market is not so concerned currently. Another factor will be the increase in the level of infection in India (especially in some pockets) leading to stringent lockdown in some important economic zones. At the same time, we are also hearing that the central government is keen to further open the economy in the next phase of unlocking. So, it seems that more than domestic factors the world developments may be more important and will determine the trend of the market. The international factors are: a second wave of infections in the world and pessimism over the extent of recession and insolvencies in the future.
About the second wave, it is not a very serious hazard as seen at the initial level or it has not yet started, only time will tell. The strength of recession, it is well known and understood that we are in a long cycle of decline for about three to four quarters on a YoY basis. At the same time, we are going to see month to month improvement in economic activity. As discussed, the risk of insolvencies has reduced for 2020 and may come back if the health policy issue continues in 2021. In the US, it has reduced due to buying guarantee by FED for private bonds and household mortgages. In India, similarly, some benefits may be expected for small and medium enterprises.
The long cycle is intact…
As anticipated a correction was triggered by pandemonium in the global market. We can see this as a short-term reaction and global markets have turned cautious post the FOMC meeting stating concerns about a weak economy, forecasting a long recession, and a rise in unemployment. The importance of the US to the world is due to it being the largest economy accounting for 1/4th of the world GDP, in dollar terms (PPP terms 15%), and the largest source of inflows. This has led to a change in the risk-on strategy of FIIs, leading to selling in emerging markets.
But the FOMC tone is positive, offering solid support to the economy with more adjustments in the future with sizes and timing of actions as per monetary policy. The Federal Reserve will provide additional support to increase the flow of credit to households and businesses to increase employment and inflation. The current plan is to buy treasury bills of $500 billion and agency mortgage-backed securities of $200billion while maintaining zero bank rate for a long period of time till 2022. The first quarter of US GDP contracted by 5%, more than the consensus forecast of 4.8% contraction. The second-quarter growth is expected to fall by 40% due to the lockdown. The Federal Reserve Board forecasts full-year 2020 GDP to fall by 6.5% with the unemployment rate at 9.3% and inflation low at 0.8% (2% is the long-term inflation target). The positivity in this forecast is that growth is expected to revamp in H2CY2020 and GDP growth to pull back to 5% in 2021.
Segments like Telecom, Chemical, IT, FMCG, and Pharma are likely to do well and safer to invest. Given the weak economic outlook for the coming quarters, only stable and attractively valued stocks and sectors will do well. Large caps with a strong balance sheet and operational strength to grow business are better placed to overcome this crisis. The Indian market has done well in the bear rally, which can consolidate in the short-term.
Accumulation is the best strategy for long-term wealth creation in direct equity and mutual funds. Gold (available in many financial tools), Short-term bonds, Liquid schemes, Government Bonds are too very lucrative in such a situation. They can be shifted in the future by increasing exposure in the equity market by means of Systematic Transfer Plans, as equity market risk stabilizes and according to investor’s risk appetite.