A bumpy ride ahead

Economic uncertainty will keep stock prices volatile

The stock market’s gyrations over the past few weeks have reflected wild mood swings across the investor community. First, the benchmark Nifty dropped by about 40 per cent from its all-time high of 12,430 recorded on January 20, to a low of 7,511 on March 24. It has subsequently bounced by about 20 per cent to near 9,000 levels. Traders have become inured to huge daily swings. The partial price-recovery has come despite a bearish economic outlook and progressively negative forecasts. The Nifty is now trading at a current price-to-earnings ratio of 21 at a time when there is overwhelming consensus that the economic activity will remain weak in the foreseeable future. By any conventional metric, the valuations are way too high. This leaves the market vulnerable to every negative news flow.  The limited upside option for Indian stocks has triggered analysts to cut ratings and targets. With a likely steep fall in earnings and expectations of a slower recovery, analysts feel Indian equities are likely to relatively lag the region. 

Though it has come down quite a bit from the levels of 83 towards the end of March, the India volatility index, or VIX, is still quite high, signifying continued uncertainty. Financial markets are good at discounting known unknowns, including events such as wars and natural disasters, but the coronavirus and the extreme measures taken to combat it have led the markets into the territory of unknown unknowns, causing this depressive trading pattern. Here’s what is known: The global economy, and India by extension, will be disrupted for a considerable period and most economists feel the damage caused by the pandemic will be greater than that incurred during the 2008 financial crisis. While there will be opportunity in that disruption, most businesses will struggle to ride out the lockdowns, and cope with the collapse in demand. If the future holds rolling lockdowns, or there is a second wave of infections, the economy could face further disruption. Possible implications can be seen in the global commodity markets, where crude futures prices dropped into the negative territory due to oversupply, while metals and industrial chemicals have also plummeted to multi-year lows. 

There is also significant variation in investor attitude. In March, foreign portfolio investors sold rupee-denominated shares worth Rs 61,973 crore and Rs 60,376 crore worth of bonds. In April so far they have sold another Rs 4,682 crore worth of shares. But the bearish overseas attitude is not shared by domestic retail investors. Domestic equity mutual funds recorded high net inflows of Rs 11,722 crore in March. The bulk of that came from individuals, so it’s clear that retail investors are keeping the faith in equity. In part, this could be due to the absence of attractive alternative assets. Debt instruments are low-paying and risky, given a scenario of widespread corporate stress. Real estate is moribund, with developers cash-strapped and construction delayed indefinitely. 

However, given the low tax collections and an already high fiscal deficit, there isn’t much headroom for the government to pump up counter-cyclical expenditure. Thus, there are considerable short-term and medium-term risks attached to equity exposure, given the uncertainties. Savvy investors will look to pick up temporarily-depressed stocks. But investors need to be prepared for a long and bumpy ride.