Markets break free from dwindling corporate earnings & lockdown blues; may go higher, dhananjay Sinha, 30stades
Dhananjay Sinha, Director - Research at Mumbai-based Systematix Group, has closely tracked the Indian economy and markets for over two decades. An alumnus of the Delhi School of Economics, he believes that liquidity is a greater force driving markets than the underlying economic fundamentals. He shares his forecast on the market trajectory:
The Indian stock markets are once again in high spirits with a 32 percent bounce back in NIFTY50 from the pandemic-induced meltdown seen in March, when the benchmark indices collapsed by over 35 percent. The rebound has taken many by surprise and most question its sustenance. There are reasonable reasons for the pervasive scepticism.
First, the number of fresh COVID-19 cases in India continues to rise with the cumulative cases now close to nearly 2.7 lakh - the fifth highest in the world and ahead of previous hotspots – Italy and Spain. And the COVID-19 scenario is likely to worsen because, unlike other countries, the lifting of lockdown is getting implemented when the exit run rate is on the rise, not flattening.
If India fails to flatten the COVID-19 curve soon enough, it will delay the opening of the economy as well as the expected recovery in economic growth and corporate earnings in the second half of FY 21.
Economic indicators worsens
Second, economic indicators and corporate earnings have been disappointing and they are likely to worsen further in FY21. Economic growth in the March 2020 slumped to 69-quarter low of three percent, translating into the decadal low GDP growth of 4.2 per cent for FY20. The on-going corporate earnings season indicates a lower than expected 3 percent year-on-year decline in the net sales of non-finance companies, while their net profit is down 14 percent despite gains from the tax cut lockdown in force for just around a week during Q4FY20.
The full impact of the lockdown in April-May 20 will be visible in the June and September quarters of this fiscal.
Given the leading indicators available till now, the contraction in economic activities, as reflected in Purchasing Manager’s Index (PMIs) for manufacturing and service sectors, has been steeper in India than most other economies.
India implemented a complete lockdown unlike most other countries. Hence, it is likely that contraction in real GDP and corporate profits in Q1 FY21 will be much steeper here.
Third, the announcement of the Rs 20 lakh stimulus package failed to enthuse with actual fiscal commitment by the government in the immediate term only limited to a measly one per cent of GDP – a tenth of the announcement. This means lower purchasing power in the economy going forward.
Clearly, concerns on growth or further compounding of COVID-19 cases are not bothering the markets. The factors buoying the market sentiment are exogenous.
Massive monetary & fiscal stimulus
Global equity indices have bounced back sharply as the momentous rise in global risk aversion in Mar’2020 have been overwhelmed by the synchronous aggressive monetary and fiscal expansion by advanced economies, led by the United States. For instance, the US Federal Reserve balance sheet has now grown to US$7.1 trillion as on June 3, 2020 from around US$4.1 trillion at the end of February this year. European Central Bank’s (ECB) balance sheet expanded by Euro 920 billion or US$ 1.08 trillion in the same period.
This has been supplemented by large fiscal stimulus averaging at around 10 percent of Gross Domestic Product (GDP) in North America and Western Europe. In India, the Reserve Bank of India (RBI) is working with nearly Rs 9 lakh crore worth of liquidity infusion in the banking system.
A significant part of this liquidity has found its way to the equity and the bond markets, putting up a floor on asset prices.
The result has been one of the quickest dissipation of risk aversion in the last 30 years.
The risk on trade has been aided by the flattening in the COVID-19 curve in most developed countries that has prompted lifting up of the lockdowns. There are initial signs of life and the economy coming back to ‘normal’ in North America and Europe. It shows in the recovery of PMIs across major economies from their recent lows. Some countries including China are now in the expansion zone.
This has raised hope of an economic recovery in 2021, when the global economy is expected to expand by 5.8 per cent after a contraction of 3 percent in 2020. This has revived hope for a rebound in corporate earnings next year.
This expectation of economic recovery along with abundance of global liquidity and record low interest rate on 10-year Treasury bonds are fuelling expansion in market valuations despite significant indication of a longer than expected recession.
So what does the future look like?
The factors that have led to the discordance between earnings growth and market valuation will continue to exist in my view, possibly in an elevated manner. Earnings growth for Indian companies will sure recover from the bottom that is expected to be around mid-2020. Relapse of foreign portfolio flows and enhanced retail participation will likely propel the momentum in the coming 12-18 months.
However, earnings are expected to lag and the market might hit a new phase of valuation distortion.
Most of the gains will accrue to fewer top companies that demonstrate market power, strong balance sheet and cash flows.
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