Market outlook: What's next after a sharp fall and a meteoric rise?

Indian market hit a wall in March as fears over rising cases of coronavirus threatened to push the global economy into a recessionary phase. The panic sell-off by foreign institutional investors (FIIs) led to massive liquidity outflow from domestic markets. The lockdown in India and a complete halt of economic activity across the globe due to rising cases of Covid-19 fueled fears of economic recession, one of the worst-ever in the last 150 years.

The sharp fall in the markets was followed up by the biggest monthly gain in nearly 11 years in April, defying weak macroeconomic conditions and a severe hit to business activity due to the nationwide lockdown. A strong rally in global markets after central banks there began to inject liquidity also built positive sentiment in India, while steps taken by the government, including the Reserve Bank of India (RBI), enthused investors. May was mixed with fall in the start and recovery later – fall due to extension of lockdown to May 31, weak macro numbers and forecasts and rising US-China tensions and rise due to monetary stimulus and expectation of hopes of a vaccine to cure coronavirus.

Now the key question is that after over 52 per cent retracement of the last fall, and the situation in the US where the NASDAQ has retraced the whole fall and Dow and S&P are 8 per cent and 6 per cent below their all-time high, should Indian investors be buying or selling now?

Investors face two risks – the risk of losing money and the risk of missing opportunity. On the one hand, there is the feeling of FOMO –Fear of missing out – and on the other hand, there is a possibility of regret in case the markets start to fall before the investors are able to sell.

Fake rally?

Histories’ great crashes have displayed fake rallies that offered investors a false sense of hope that proved to be momentary.  The 2007-2009 market crash gave us a gain of more than 25 per cent that was eventually relinquished. The bear market from 2000-2002 saw three separate rallies of around 20 per cent before finally settling in at a bottom more than 50 per cent lower than the peak.

The relentless supply of easy money through monetary stimulus (and now fiscal stimulus) is acting as an anesthesia so that the Covid-19-related pain is not felt temporarily by the economy or businesses.  Even at these levels, equity allocation for global investors is just around 40 per cent with holdings of cash and bonds being elevated. There is still plenty of room for investors to raise their equity allocation over the medium-to-longer term. India’s benchmark weights in the MSCI and FTSE indices are likely to be raised in June and August respectively, as a result of the government’s decision to increase foreign investment limits in domestic companies. This could bring in some $6.5 billion of FPI flows into India. Also, a normal monsoon can allow agriculture to be the torchbearer of gross domestic product (GDP) growth in the financial year 2020-21 (FY21). All these mean that there could still some steam left in the rally before we see a correction of the latest rise. FPI flows have turned sharply positive as a result of the supply of cheap money.

The global recession seems like a certainty due to abrupt, the synchronised, and global shutdown of economic activities. The current crisis is worse than the 2008 crisis in terms of speed and depth of the downturn, but on the positive side, we may recover faster than in 2008. Given the nature of the crisis and consequent containment measures, forecasting corporate earnings for FY21E has become difficult with existing earnings estimates facing sharp downside risks. Chief Financial Officers (CFOs) of major corporations around the globe are more likely to believe the Dow Jones Industrial Average (DJIA) will retest its coronavirus crash level, below 19,000, before reaching another stock market record high above 29,000, according to the second quarter 2020 CNBC Global CFO Council Survey.

Investing strategy

In such uncertain times, an investor is better to stick with ‘money-in’ businesses (companies with cash) than ‘money-out’ ones (leveraged companies); lending/collection models with a high human component are susceptible to a prolonged shutdown; a prudent investor should follow a ‘zero-tolerance’ policy on balance sheet uncertainties. Going ahead, strong balance sheets will be a competitive advantage. Larger companies will gain share. There will be substantial bankruptcies and layoffs, especially among the small and medium enterprises (MSME) sector.

Going ahead it is likely that the sectors that were outperformers in the previous bull market may trail the market recovery and some other sectors that were not liked, under-owned, and valued attractively may get in favour. 

Although it is true that the markets bottom out ahead of the economy, the fact that we do not have a handle on how worse the economy can get from here means we should not try and anticipate the market bottom now. Asset allocations need to be reviewed to set right and equity portfolio reviews need to be done rigorously so that the current up move can be used to move out of stocks which may not withstand the pain and disruption. For investors who are underinvested in equities, a proper systematic investment plan (SIP) in indices or select stocks over the next five – nine months is the need of the hour for participating in the ensuing up move later.

Deepak Jasani is head of retail research at HDFC Securities. Views are his own.