Why investors should be wary of the 'Unlock' trade: Let's look at the logic

Consumption growth could be disappointing and stock prices have run up fast

Starting with the third quarter of financial year 2020-21 (Q3FY21), we have seen “unlock” trades at various times. Whenever lockdowns have been eased, traders have taken long positions in consumer-facing businesses. Let’s look at the logic.

Since March 2020, sectors like retail, personal vehicles, hospitality, aviation, fast-moving consumer goods (FMCG), multiplexes, etc., have been under severe pressure. As a result, there’s been a low base effect. Every company in these spaces has suffered top line contraction. Many suffered losses, especially in the first half of FY21.

In Q3FY21, there were hopes of a festive season revival, with the first lockdowns lifted. That did not happen. Consumption in Q4FY21 seemed headed towa­rds normalcy. But the second wave hit in April 2021. Along with the approach of the festive season, and the receding second wave, more unlock trades are happening now with recent interest in consumption-oriented stocks.

Is the optimism justified? The low base is undeniable. This will boost results. There are other positive indicators. Inflation is still high but it eased in July. The Index of Industrial Production for June was up 13 per cent year-on-year (YoY) after falling 16.6 per cent in June 2020.

We saw positive values for Manufacturing and Services Purchasing Managers Indices in July, and strong goods and services tax (GST) collections in July. July car sales were also good, YoY and versus June. This was true for two-wheeler sales as well. But both car and two-wheeler sales were well below July 2019 levels. Moreover, Maruti has already announced price hikes to cope with rising input costs and this could affect middle-class demand.

The negatives are as follows. Governments everywhere are bracing for a third wave. India’s vaccination drive, with 32 per cent of the eligible population having rec­e­ived one dose, is well below herd immunity. The festive season could trigger another wave of mass infections.

Consumer confidence surveys show poor sentiment. The Reserve Bank of India’s (RBI’s) Consumer Confidence Surveys in July said most ho­u­se­holds reported lower inco­me and worries about inflation. The “Current Situation Index” is close to a record low, while the “Future Expecta­tions Index” is slightly positive. Around two-thirds of CEOs of large corporates polled by CII in August expect GDP growth in FY22 at 9 per cent or less, which is lower than official estimates. A growth rate of 9 per cent on the back of 7 per cent GDP contraction in FY21, would only pull GDP back to near FY20 levels. The Retail Busi­ness Survey by the Retailers Association of India (RAI) showed retail sales in July were at 72 per cent of the pre-pandemic level of July 2019.

There’s a long way to go for recovery. Fitch expects consumption recovery to be complete only in FY23. Total hous­ehold spending in real terms is forecast to reach Rs 72.6 trillion in FY22, below the FY20 level of Rs 73.5 trillion. In FY23, Fitch projects real household spending of Rs 77.7 trillion, 5.8 per cent more than FY20.

Putting all this together, we can expect consumption growth through the second half of FY22, but the growth rates could be disappointing. Given a fast run-up in stock prices due to “unlock” trades, one should be cautious about increasing exposure. Valua­tions may be unsustainable.