THE MARKET & ECONOMY
WHO declared the Pandemic more than 3 months ago but there is still no foreseeable end. Two intertwined factors - the economy and the epidemic inhibit any meaningful forecast. As we come to the end HI 2020 a review of markets and economy both global and domestic, will put in perspective the challenges ahead.
Global Markets: US Markets plunged 30% in March from an all-time high in Jan 2020. Surprisingly markets rose sharply in April-May anticipating a V-shaped recovery following lifting of lockdown end-May. Dow and S&P (ref charts) are currently trading 15% below Jan peak. NASDAQ (dominated by Tech) fell 33% in March, but recently scaled a new peak, driven by the big four-Microsoft, Amazon, Facebook and Google –beneficiaries of the pandemic. The uptick was aided by Stimulus Package of USD 2 trio (10% of GDP) and Federal Reserve pumping liquidity and cutting interest rates to near zero.
In the hardest hit Europe, Eurostoxx and FTSE in UK fell 40% but (like US) recovered lost ground and is currently trading at 15-20% of its 2020 peak. European Governments as well as the UK doled out Economic support programs, whilst BOE and ECB, slashed interest rates and injected massive liquidity just like the Fed. This led to strong market recovery, way ahead of the economic cycle.
Volatility (VIX chart) exceeded 70% and remains at an elevated level of 35%. Correlations are at a 20 year high in market assets across the globe. Investors flight to safety, strengthened the USD initially, but due to excess liquidity USD is likely to weaken in the near term. Euro strengthened to 1.12 and Sterling is currently trading at 1.23, below Brexit low of 1.29. A price-war in March between Russia and Saudi and lack of storage capacity plunged Oil into negative territory. Oil recovered (WTI chart) as production was rebalanced with OPEC support. Even as the global economy picks up in HII 2020, oil demand is estimated to be 30-40% lower than last year.
Domestic Market: Heavy selling by FFIs in March routed the Indian stock-market which aligned with global markets plummeting 40% to a low of 7,500/ 25,600 (NIFTY/SENSEX Chart). Market volatility (India VIX) peaked at 80% in sync with the US markets. Just like in US / Europe, NIFTY/ SENSEX recovered -currently 10,200/ 34,700 on the strength of the Economic package (Rs 20 lac cr) announced by Modi Govt and strong liquidity support by RBI. The selling pressure of the FFIs (USD 15 b) contributed to an almost 8 % fall in the Rupee, currently trading at 75.5 (USD INR chart).
Global Economy: In response to the Pandemic Governments imposed social distancing; lockdowns and quarantines and ring-fenced their borders by banning international flights and severely clamping down inter-state movements. Global economic activity and trade plunged rapidly due to closures in key sectors – airlines; tourism & hospitality; real estate; restaurants and other services including schools and colleges resulting in a sudden surge in unemployment. However, the pandemic curve flattened in Europe and parts of US by end of May leading to a phased reopening of the economy. Whilst US had an all-time low unemployment rate of 2%, following the lockdown unemployment rose to 40 m (15- 20%). With reopening job creation is gaining momentum as economists predict a recovery by Q3/4. However, a second wave is not ruled out since the southern states have recorded an upsurge of cases and in overall terms the curve is yet to flatten in US. Likewise, UK - a service economy has been badly hit by the pandemic and also by Brexit which came into effect end Jan. Europe is already in recession, since the Pandemic hit them early. The depth of the contraction in the OECD is estimated to vary from 15-20% in Q2/3 and even extend to Q4. China, the 2nd largest economy, has varying estimates of contraction as some believe it could be as high as 40%, all of which will certainly drag the global economy into recession for the best part of 2020.
Domestic Economy: The trendline for the Indian economy in the last two years is a declining GDP growth (5% fiscal 19-20). In Feb Budget FM forecast nominal GDP growth 10% for 20-21 but economists now reckon GDP will contract by 3%. The epidemic is likely to continue since there is no sign of curve flattening as cases increase especially in the Metros. The budgeted fiscal deficit of 3.5% at the federal level will be breached due to the economic stimuli and handouts announced by FM in for the underprivileged. Taking into account the deficits of the individual States estimated at 2.5% and other measures– Health-care support, recapitalization of PSU banks and bleak divestment prospects (Air India / BPCL amongst others) the actual deficit could easily run past 5-6%. In June Moody’s downgraded India to Baa3 lowest level of Investment Grade. The only silver lining is lower oil prices alleviating current a/c deficit (CAD declined to 0.2% in Q3 19-20). It remains to be seen how the export / import performance is impacted by the logistics breakdown since the transportation sector will take time to recover its efficiency.
Conclusion:There is a huge disconnect between the economy and the markets as the latter is always forward looking and have priced in the best-case scenario. Consequently, markets will remain choppy as the pace of reopening is uncertain and the threat of a second wave, since a vaccine is not expected before 2021. Key sectors – auto, airlines, transportation and manufacturing are just limping back and as Jeremy Powell – Fed Chairman recently testified that recovery is a long way off - end 2021. Indian economy will have to contend with:
• Inflation may return due to supply demand imbalance post-lockdown and the excess liquidity in the system.
• Bank funding will get harder, since banks are undergoing a major revamp. NBFC credit is not only costly but extremely limited given the crisis in this sector.
• Unemployment will remain elevated compounded by the migrant crisis. Corporate retrenchment will increase as companies pursue cost-cutting and non-essentials. Consequently, consumer spending (60% of Indian GDP) will drop significantly.
• Real estate, especially commercial will be badly affected as companies downsize offices and adjust to a new norm of work-from home. Likewise travel and hospitality due to curtailed demand.
Whilst India may eventually benefit from China aversion policy in US / UK and to some degree Europe, this can only have an effect in the long term. The short term will be much harder as there are many obstacles in the operating environment.