Halfway Back From The Market Bottom. What Next?

Stock markets are seen as a leading indicator of sentiment about the state of business activity and its immediate prospects. In most cases, the levels that markets and stocks trade at are thought to be the levels that, in a utopian scenario, discount the visible earnings for the benchmark companies as an aggregate, at an agreeable price. However, in the periods of greed and fear that frequently come along these levels get distorted, often for a considerable period of time.

While the Indian market is no stranger to corrections and pullbacks, the unprecedented ferocity of the fall in March, and the sharp rise in April has left many scratching their heads about what exactly shifted so dramatically in just a matter of weeks. Going into the weekend at 9,860, in five weeks the Nifty had completed a retracement of almost 45 percent of the preceding fall, which was from 12,430 in early February to the recent low of 7,511 in late March.

What do the underlying macro-economic trends, corporate earnings, market technicals, fund flows, and correlations with leading global indices indicate?

The Economic Reality

In the six weeks since India went into a nationwide lockdown due to the coronavirus pandemic, we’ve seen repeated revisions in estimates of gross domestic product for the financial year 2020-21. Forecasters have not been able to get a handle on how much activity has been and will be lost due to the shutdown that has entered its third phase.

Along with that come lower tax collections, higher government expenditure, and a fiscal deficit higher than estimates drawn up in the Feb. 1 union budget. Income Tax and Goods and Services Tax collections will fall, let alone small-ticket items like the sin cess and entertainment tax. Fiscal expansion is a double-edged sword. The economy needs the kickstart, but rating agencies have already sounded the alarm. A downgrade may invite the wrath of global investors, which will impact equity flows and the currency as well. Few foreign investors want to invest in a country where a sharp currency devaluation could eat into market returns. For listed companies and their investors, all this signals lower revenue, lower profit, and the risk of fund outflows.

Earnings Recovery Hopes Were A Mirage

The consumer sector’s January-March performance paints a bleak picture. The premier staples company in India, Hindustan Unilever, delivered volume de-growth. It’s not just HUL and consumer demand. For the same quarter, Reliance Industries’ profit fell 73 percent, Tech Mahindra’s dipped 30 percent, banks like Axis and IndusInd have upped provisions.

This is the quarter when an economy slowing for a few years now, was met by the disruption caused by the coronavirus. If a month of nervousness, two weeks of mild restrictions, and one week of a full-blown lockdown can do this, what does it say for the April-June quarter? Even beyond the lockdown, demand may arguably not return to peak levels because of lingering social restrictions, as well as salary and job cuts.

Much like the trouble with GDP forecasts, how do you calculate the earnings impact of this lockdown at this juncture? At this stage, it’s hard to compute.

Demand At These Prices And Supply Of Paper

The trailing price-to-book multiples are near the long-term averages of 18.5x but higher than the two points of panic in recent years – 13-14x after the Taper Tantrum of 2013 when India was among the ‘Fragile Five’, and 10-11x in 2008-09 following the global financial crisis. While the pullback could extend further if a significant stimulus package is announced, all is not well on the ground.

There also is a fair amount of supply of paper to contend with in the near term. The mother of equity fundraising ever done in India is on the anvil, in the form of the rights issue announced by Reliance Industries. GSK, as Bloomberg reports, is out to sell its $3.7 billion stake in HUL. The scale of the coronavirus response could tip the government’s hand in getting aggressive on disinvestment. Investors should be mindful of all of this as well.

The Risk Of A False Dawn

So what explains the fact that we have retraced well over 40 percent of the fall? Was the panic in March too much too fast? Or, for the second time since the global financial crisis, we are seeing the gush of liquidity opened up by western central banks chases asset prices again, instead of being absorbed by the real economy?

The Indian stock market’s movement in 2008 may hold some lessons. Investors witnessed a number of such noteworthy pullbacks, but from its top in Jan 2008, the market found its bottom over 60 percent lower, in March 2009.

Market players on Wall Street face a similar dilemma of what to make of a strong rebound in April after a precipitous fall in March. In the last 8 weeks, when we’ve seen global experts look further out than the 2008 crisis and draw parallels to the U.S. Great Depression that began in 1929 in trying to understand this coronavirus crisis, it’s been about the underlying economy. Now, this Bloomberg op-ed over the weekend cautions that there are parallels to 1929 and 1930 to learn from for stock traders as well, to not get “fooled by the recent rebound.”

Immediate Potholes?

The charts tell an interesting picture of what may lie immediately ahead. Most technical experts speak about retracements and cluster supports or resistances as key monitorables in volatile markets. Having done 45 percent, the 50 percent retracement of this fall comes at 9,970 levels for the Nifty. We are almost at a point where a conflux of resistances emerges, in the 9,970 to 10,330 zone.

That said, markets have a mind of their own, and by design, make the best of minds look silly. The last decade is replete with instances of stock markets climbing walls of worry, on the sheer force of cheap money. Liquidity may desert a market or embrace it at the most unexpected times. But that makes such a market entirely reliant on a single driver, fund flows, in the absence of all others – underlying growth, compelling prices, earnings visibility. That’s skating on thin ice.

Niraj Shah is Markets Editor at BloombergQuint.