The Economy is down, wait, the Market must be falling?

Let's see how the market is outperforming, even when the economy is not doing well. After all, markets are an indicator of the economy. 

Bad news all around.

1. Global Politics

- China is in the Cold War with the US, Hong Kong, Taiwan & India.

- Ahead of Trump Election Trade Deal policy hostile.

- China's President Xi Jinping reiterates his support for multilateral cooperation.

2. COVID - 19

 In the World

- 1st phase of Pandemic is 3-4 month cycle

- The risk of 2nd phase could cause economic revival, The spread is still at high speed in many countries.

India Specific.

- Cases are raising Doubling every 25 days at a growth rate of 2.8% daily.

- Markets absorbed lockdown but if there is 2.0 wake of transmission, markets will likely sell-off.

3. Crude Oil

- Crude demand dynamics have been impacted a lot due to covid surged, lockdowns, and 2020 Russia–Saudi Arabia oil price war.

- WTI Crude Traded at a negative price for some time (April 19) due to excess supply and storage worries. 

4. Gold

The demand for gold surges at the time of crisis due to investors be looking at safer options, As gold is one, this will lead to skew up the gold price, evident in the past as gold prices have rocketed at times of crisis or economic recession.

Bitcoin, seen as an alternative to gold by millennials, seems to wrong as Bitcoin is acting like a risky stock than Crisis hedger gold.

5. Markets

Economic Slowdown across the Globe.

IMF expects the Indian GDP growth rate at 1.9% (contraction by 4.5%), followed by FY21 at 7.4%. While different agencies and think tanks have estimated different numbers but consensus says there will be a contraction. 

GDP Growth Rate - INDIA

The Indian economy was already struggling with structural tailwinds, such as GST, Demonetization, Higher Real Interest rates, Trade War, and Change in the Consumer Preference. Policy changes seem right, in the long run, to have an impact in the short term. The Indian economy has taken hit due to slowdown across sectors such as Auto, Consumer Durables as dragged the economic growth lower. The slowdown is also attributed to struggling rural economy, Liquidity crisis in the NBFC's post-ILFS & DHFL Defaults, adding to that consumption weakness has led to limit in Capex plans.

Further lower spending by government, non-availability of funds due to NBFC's crisis and slower rate transmission of rates from banks as skewed the demand lower in real estate, power & Infra. USD-INR is weakening.

As overall slow down as they made the banks more cautious as there are pilling up of defaults as seen a dent in asset qualities for banks. Exports have been impacted due to the trade war between US-China.

Jobs Losses

Here are some of the media headlines which reflect the mood of the current situation

Some Wariness!

-RBI's FSA [Financial Stability Report] has warned that there would be a rise in defaults.

- It is highly feared that a second wave of the spread of the virus.

Wait, Reading all this, You would feel the economy is in a slowdown. As a result, the market should reflect the economy; markets, after all, an indicator of the economy?

On the contrary, despite such broad economic-based slowdown, the benchmark indices recovered and traded near highs.

Now wonder how it is possible?

Making Sense of the market.

1. Markets Driven by Liquidity, Not Fundamentals.

Markets as favorable responded to Monetary and Fiscal stimulus measures. Lower interest rates are beneficial for the economy as well as companies as it leads to demand push. The government has also announced several steps, including corporate tax cut, easing of FDI norms, GST rate cut and,re-capitalization and merging of PSU banks.

A.Policy rates 

Central Banks globally proactively related to policy rate some have seen even negative interest rate (As we discussed in the previous week)

B.Stimulus

Massive fiscal & monetary stimulus has been witnessed across the world.

C.FII AND DII inflows

Inflows from both have been seen from Foreign Institutional Investors & Domestic Institutional Investors. FII & DII have a significant influence on markets. They actively Buy and Sell. The market is pricing inflows from FPIs (foreign portfolio investments) due to an increase in India's weight in the MSCI and FTSE Index. 

Central banks globally proactively announced policy rate cuts to support growth. Also, Policymakers in some countries have supported by 

A. Direct Cash Transfers 

B. Injection of liquidity by central banks 

C. Support to MSME'S by cheap loans.

2. 'Better' or 'Worse' more dominant than 'Good' or 'Bad.'

In the markets, the correlation between economic data and stock market returns is Better or Worse dominants than 'Good' or 'Bad.' So the key lies if the economy is getting better or worse. Stock markets are discounting machine in which it discounts future earnings and starts pricing in it today. In general, sense price is reactive, and value is proactive of future earnings.

So the key lies with better or worse than 'Good' or 'Bad' w.r.t economy?

Thread 1:Signs of Normalisation of Economy

OECD

PMI Data

PMI data and OECD data have shown a V shape recovery. They are a leading indicator of economic cycles (A) PMI - is an early indicator of market conditions, which helps to find new orders purchases, inventory procurements levels, production, supplier delivery, and employment as a whole. India's PMI Index has also improved from 27.4 in Apr-20, to 47.2 in Jun-20. (B) The OECD is designed to provide early signs of turning points in the business cycle, showing the fluctuation of the economic activities around its long term potential levels. Both indicators help to find current and future business conditions. OECD also shows signs of improvement in 102 in Mar-20, to 89 in April-20 now at 93 July-20.

As of Jun-20, GST collection is at ~Rs 91,000 crore is almost 3x of April-20 month, which was ~Rs.32,000.

Other indicators, such as power Consumption, E-Toll collection, and Consumption of Petrol and Diesel as seen a spike. 

Total Vehicle sales have seen pent-up demand of close to 39% from the month of April.With NBFC's seeing a reimbursement of loans to durable consumer products. Also, the Unemployment rate falling to 7.9% from hights of 27.1% (Offical Data) 

Consumption indicators

'This early signs of tailwinds tells a lot about worst likely to behind us.'

Tread 2: Rural economy to recover much faster than urban

Rural economic recovery would be fatter compared to urban. As supported by a Good monsoon's Higher allocation of stimulus to Agri and Agri reforms itself with lower virus spread due to which the intensity of lockdown is comparatively low.

Supporting Data Points –

A.Significant pickup in Tractor Registrations- chief proxy to gauge the health of the rural economy

B. Good Monsoon: 

C. Higher Fertiliser Sales: Fertiliser sales jumped 83% for Apr-Jun quarter vs. last year

D. Cement sales and two-wheeler sales are normalizing

E. Higher MNREGA allocation and MSP hike

F. Structural measures for Long Term to increase farm income-'doubling farmers income by 2022' - NITI Aayog

Structural Reforms in Agri

Removing the Essential Commodities Act- It is more of a price stabilization reform

Freeing up the APMC market- Win-Win For Farmers & Buyers

Supporting contract farming- facilitate a fixed selling price to farmers, and provide a certain quality

3. Medical Progress- Vaccine 

Researchers worldwide are racing to invent, produce, and safely test the Effectiveness of vaccine. Currently, 165 vaccines have been developed, of which 27 vaccines are in the human trials stage. A vaccine typically requires several years to reach clinical trials, but this times it's different.

Typically vaccine undergoes following stages:

1.PRECLINICAL TESTING: Scientists give the vaccine to animals such as mice or monkeys to see if it produces an immune response.

2.PHASE I SAFETY TRIALS: vaccine to a small number of people to test safety and dosage as well as to confirm that it stimulates the immune system.

3. PHASE II EXPANDED TRIALS: vaccine to hundreds of people split into groups, such as children and the elderly, to see if the vaccine acts differently in them. 

4.PHASE III EFFICACY TRIALS: vaccine to thousands of people and wait to see how many become infected, compared with volunteers who received a placebo. 

5.APPROVAL: Regulators in each country review the trial results and decide whether to approve the vaccine or not. During a pandemic, a vaccine may receive emergency use authorization before getting formal approval.

Vaccine Types

1.Genetic Vaccines- Moderna Phase III, Imperial College London researchers Phase III.

2.Viral Vector Vaccines- AstraZeneca and the University of Oxford Phase III, CanSino Biologics Phase II (LIMITED APPROVAL).

3.Protein-Based Vaccines- Anhui Zhifei Longcom Phase II, Novavax Phase II.

4.Whole-Virus Vaccines- Sinopharm Phase III, Bharat Biotech With ICMR Phase II.

Data Source: NYT 

4. Narrow Sense

-Lack of historical correlation: Historically, there no much correlation between Nifty returns and GDP growth rate.

-The market cares about factors which do not show in GDP: The recent corporate tax cuts have helped may large companies 

-A lot of standard companies are Private: Drivers of consumption like Startup's (Ola, Flipkart, etc.), Major car companies(barring Maruti), Hotels barring (Taj, etc.) are Private. Hence markets fail to capture the overall trend in the economy.

-Too much tilt to the financial sector: Financials are made of 42%

Nifty outperformance is skewed towards a few heavyweights comprises of 7-11 Scripts. These companies remain unaffected by the slowdown, and they continue to outperform by profitability or market share.

5.Post-COVID Opportunities and Risks:

Long-Term Themes Accelerated by COVID

-Work from home- New Norms, low-income earners were more likely to be fired and less likely to work from home.

- State and local government budgets: Already challenged before COVID-19, state/local

governments are projected to face severe budget shortfalls

- Supply chains: A potential trend towards re-shoring supply chains in areas such as medical supplies could present significant opportunities.

- Capex: Companies had already been shifting their capital expenditures towards software/research and development.

Compacting all these, let's see what markets are pricing in.

Vaccine for Covid in the near term with stimulus and rate cuts has helped the companies lower their cost of capital and improve their liquidity position.

All this seems hanky Dori, But we don't know what can go wrong such as

-India-China Border Faceoff

-2nd Wave Virus (More Deadly, History says) followed by lockdowns

-US Elections- Trump plays an essential role in supporting the markets.

If the actual scenario plays out better like a vaccine is found in the next few days, New policy Reforms will help further.

If the exact scenario plays out worse than what is priced by the market, equity markets may fall from the current level.

Markets are always forward-looking than current conditions. It's always pricing in the future expected earnings.

Happy Investing!

Data Pedigree:

Aswath Damodaran- https://bit.ly/3k5PTIr

NYTimes - https://nyti.ms/3gja6rE

IMF- Database

WHO 

Blackstone Investment Strategy

Media Articles on Job cuts

Refer Disclamiar

-Vinay Dwarakanath