What should be the action point for equity investors at this time?

Equity markets have fallen sharply across the globe over the past few weeks. We are in unprecedented times as fear has become the dominating emotion and there is a crisis of confidence all around.

While the Covid-19 situation remains grim in most parts of the world, what comes as a huge solace is the sharp drop in additional cases at the very epicenter of the endemic breakout in China, as it demonstrates the ability of the human race to overcome any grave situation.

While market reactions toward the health crisis is justified to a large extent, at the same time a lot of it is driven by fear and overreaction, which is probably the most common trait of human behavior in capital markets.

People are wired to react to situations of fear and greed. This thought stems from the fact that while the number of infections has topped 1.2 million, the death toll stands at 64,734, about 5 per cent, exemplifying that the virus is more contagious and less fatal in comparison to previous episodes of HIV, small pox, Ebola, swine flu, etc, where the mortality rate toll was much higher. The sharp correction in the market clearly shows that investors remain fearful.

Of course, the world is in contraction mode and will continue to be in same phase for some time thanks to Covid-19. While the rapid spread of the disease surely demands one to be aware, prepared and cautious, but there is no need to hit the panic button.

If one were to magnify the demographic statistics of the people infected by the virus, it appears to be linked to co-morbidity, as the most affected are people of over 60 years. This indicates that the healthy can fight the virus like any other viral flu. It’s important to have the confidence in ourselves and in the human race for its ability to deal with any precarious situation, be it Corona or Ebola or Sars. We strongly believe this too shall pass.

Market Correction: An Opportunity in Disguise

Equity markets globally have corrected 25-35 per cent from their peak levels due to multiple reasons, including the outbreak of Coronavirus (COVID-19), significant correction in crude oil prices due to failure of talks between Opec and non-Opec producers on increasing/extending production cuts to balance the global oil market. Domestically, we have also seen the unfortunate episode of YES Bank being put under a moratorium. But the key positive is the proactiveness with which the government and RBI have been handling the situation to prevent the negative fallout of the situation.

While the global macro backdrop turns increasingly beneficial for India, the current correction in the Indian equity market is the result of the risk-off sentiment, that has impacted all equity markets globally.

Human Behaviour and Markets

Some things never change. From the equity market’s perspective, greed & fear are two such emotions. History is replete with examples where greed & fear have impeded investor’s ability to take rational decisions (only to repent later). One must invest when everyone turns fearful and assets are available at a reasonably good prices. Markets never give returns in a linear fashion. No matter how sound a market/company is, its return would always rise in a non-linear manner.

Though we must admit that investor behaviour is changing gradually and they are willing to ride out the storm and even add more money during the bad phase of the market.

We believe the current fall in the market presents an opportunity to add to one’s equity exposure. From a historical perspective, we are hopeful that the impact of Covid-19 will smoothen out within three months, as observed during ZICA, IBOLA, and SARS crises, which were more deadly than the Coronavirus. Even then, markets had corrected in the short term owing to panic, but then went on to rose ten-folds from there.

Market Correction: A Historical Perspective

History suggests whenever markets have faced turbulent times, they has eventually been able to overcome that and gone on to make newer highs. We have seen Sensex deliver a one-year average return of 50% in six similar instances earlier. There is no reason to believe that it would be any different this time.

What makes us bullish on markets in the current negative environment?

We remain extremely constructive on the outlook for the Indian equity market, as India seems to be a major beneficiary of the reasons behind the current correction.

• Although the Covid-19 started in Wuhan, China, and has spread to more than 160 countries with the US, Italy, Spain and Iran getting impacted significantly, it is heartening to see significant improvement at the epicenter of the virus and the first casualty nations i.e. China, and also in Hong Kong and Taiwan, and markets there are no longer as nervous as elsewhere in the world. While pessimists will doubt the authenticity of the Chinese data, what gives us comfort is the fact that Apple and Starbucks have already opened more than 80% of their outlets in China, while Toyota has opened all of its factories in China.

• India is expected be a major beneficiary of the de-risking of supply chains away from China post this crisis. The Indian government has already cut the corporate tax rate to 15% for new manufacturing entities, making India globally competitive. This should enable the country to attract new investment. India also has a large trade deficit with China ($50 bn officially), which will come down as imports drop. This, in turn, should bode well for domestic manufacturing.

• India is expected to be a major beneficiary also of the correction in crude oil prices. India imports $115 billion worth of crude oil annually. A 1% reduction in crude oil prices saves India $1.2 billion annually. With crude oil price having corrected 40%, it offers Indian economy a potential $50 billion stimulus, and a part of it can be used to fund the fiscal deficit by way of higher excise duty.

• Globally central banks, including RBI and the US Fed, have cut interest rates in an emergency move and extended liquidity lines/QE program to ease the impact of Covid on economies. Central banks of India, Canada, Australia, New Zealand have also slashed rates and ECB has extended liquidity lines to support the economy. This flush of funds will find way to emerging markets once the health situation improves, and that will be a big push factor for Indian equities.

• While there could be a hit on corporate earnings for one and two quarters due to Covid-19 outbreak, we expect normalisation of earnings in FY21, if the virus is contained within a month or two. Nifty has corrected to 8,000 level, which is below the levels when corporate taxes were cut (implying a 12-15% increase in EPS). Post the correction, valuations have become more attractive with Nifty trading at 14 times FY21 EPS.

Importantly, with the fall in 10-year G-sec yields, Nifty earnings yield have converged with bond yields, implying that the market is not paying any premium for future growth. Historically, periods like these have always been followed by significant rallies in equities.

What Should be the Action Point for Investor?

What we are currently experiencing is volatility, not absolute loss. As is always the case when markets correct, the prophets of doom and gloom have once again sounded the clarion call. A short while ago these very same prophets were flaunting India as the economy of the future – highest GDP growth among large economies, youngest population, huge workforce, rapidly growing consumer numbers, growing purchasing power, fast developing infrastructure, and so on.

Has all this changed in a few months? The answer is a resounding ‘NO’. We know that markets do come back from every correction and eventually make new highs. Even the 2008 market collapse – the worst in recent times – was a testimony to this. From highs of 6,200 in January 2008, the Nifty collapsed to a low of 2,600 in March 2009. At that point, many market pundits predicted that it would take many years, possibly a decade to recover from what they called ‘complete and utter devastation of the world’s financial markets’.

However, the markets were back to 6,100 level by October, 2010, in a span of 18 months! History has shown time and again the continued progress of mankind, and there is no reason that that trend will reverse this time. Staying on course is what makes one a successful investor.

If you’re investing for the next five – 10 years, then your focus should be on the opportunity and the way to harness it. One should keep investing as per her goals and leverage these falls. The current correction in the market provides investors a huge opportunity to increase allocation to equities with a medium- to long-term view.

(Vaswani is Chief Investment Officer with Future Generali India Life Insurance. Views are her own)