The expectation that restrictions may last weeks and not months explains the market’s apparent casual view of the pandemic
Despite the scary increase in daily new cases and deaths in the second wave of Covid-19, and even as nearly every major state government has imposed activity restrictions, stock markets have barely moved. The few good indicators of economic activity that can be tracked on a daily/weekly basis show clear evidence of a sharp slowdown. Petrol and diesel demand slowed sharply in the second half of April, and for the month as a whole, were 4 per cent and 10 per cent respectively, below the levels seen in April 2019. Power demand was higher than in April 2019, but only marginally so. The generation of e-way bills for goods and services tax (GST) kept declining through the month of April. Google’s mobility indicators show grocery and retail movements having fallen to levels last seen in August 2020. And yet, the Nifty index that tracks the top 50 stocks is just 3 per cent off its all-time high, and the indices tracking small- and mid-cap stocks are doing even better.
In an earlier Tessellatum (“Signals from the Market”, February 2020), we had explored some reasons why markets and the local economy are often disconnected, several of which are in play.
Given the participation of foreign institutional investors, the performance of stock markets has to be viewed relative to markets globally, and on this measure, the impact is visible. In April, Indian stocks were ranked 43 among the 50 largest markets globally in returns, underperforming global equities by 5 per cent: They fell 1 per cent, but global equities were up 4 per cent. In May thus far, Indian equities have done a bit better, outperforming by 2 per cent. This is possibly because markets can now extrapolate to an end to the pandemic: While active cases nationally have continued to rise, regions that were hit by the second wave like Maharashtra and Madhya Pradesh have begun to see a decline in active cases. In Mumbai, for example, these have fallen by 48 per cent from the peak, and the number of sealed buildings has nearly halved. The decline from the peak in Delhi is only 14 per cent, but the positive test ratio has also fallen to the lowest in three weeks. The assumption may be that other regions currently in distress may follow a similar pattern.
Further, as always, beneath the apparent stability of the headline indices, there has been a divergence in sector performance: The understandable correction in banks, cement, and consumer discretionary has been offset by an also understandable jump in metals and pharmaceuticals. Record high metal prices globally have allowed domestic metal companies to offset weak domestic demand with high-priced exports, and the boost to profitability is also driving significant deleveraging. The surge in demand for medicines and vaccines, together with the financing and liquidity support to the sector announced by the Reserve Bank of India (RBI), have helped the pharmaceutical stocks.
Thus, the market is not completely ignoring the impact of the pandemic. To understand why the impact appears muted compared to the scale of human tragedy, let us analyse the impact on the most important variable that markets focus on: Profit expectations for listed companies. There are two parts to this, the first being the profit expected over the next twelve months (or “forward earnings”), and the second the impact on medium-term growth in profits.
An important characteristic of forward earnings is that they are like a treadmill. If two months of partial lockdowns drive a reduction in profit forecasts for the fiscal year 2021-22 (FY22), at the end of that two-month period, the twelve months ahead have no restrictions and include two months of FY23. If lockdowns are expected to last weeks, instead of months, investors may decide not to sell stocks now and buy later, as it is unclear if they would be able to buy at a lower price.
That brings us to prospects for medium-term growth in profits. This would also depend on the duration of activity restrictions: If they last a few weeks and not a few months, they can be “looked through”. If hypothetically, 10 per cent of national gross domestic product (GDP) is constrained for two months, 1.6 per cent of annual GDP would be lost. In the first wave of much more intense lockdowns, the GDP loss was about five times that number. The distribution of this income loss is also important, as a meaningful part is borne by the government through tax losses and subsidies; and is effectively a socialisation of the loss over current and future taxpayers.
Another substantial part is what we can call “water under the bridge”, as people earn less and also consume less (the reason GDP falls). The challenge of course is that the drop in income and expenditure is for different sets of people, creating excess savings for some households and weakening the balance sheets of others. This may have the most meaningful impact, but is small in size: It hurts discretionary demand from low-income households until their net worth recovers.
How the rest is split depends on decisions by economic participants. In the first wave, even large companies delayed payments to their suppliers, abruptly cancelled orders invoking force majeure, or laid off contract workers. In the second wave, at least thus far, firms are trying their best to keep operations running (though many are struggling because of workers or their family members getting infected), and trying to hold on to even temporary workers. This behaviour is also based on the expectation of a short-lived disruption. If GDP losses are more evenly split, the lasting impact on individual firms and households will be lower.
One must also consider the risk such a harrowing experience can have on the consumption sentiment of individuals and investment sentiment of firms. A pickup in the pace of vaccinations would help people shed their fear: That the supply of vaccines is expected to treble in the next few months may be supporting the optimism of investors. To get firms to push through with their future investments, the government may have to continue to prioritise growth, like it was before the pandemic. This also appears to be a reasonable expectation, given the Rs 4.5 trillion of surplus cash with governments at the end of the last fiscal year, robust GST collection in April, a conservative fiscal consolidation path, and a central bank supportive of growth.
Going forward, we may see volatility in global financial markets, which may show up in India too, but we expect India’s apparent market indifference in the face of a harrowing pandemic to potentially continue.
The writer is co-head of APAC Strategy and India Strategist for Credit Suisse