The June’20 quarter ended up being the best for US equities in over 20 years. For India, this was the best quarter in 11 years,sinceJune2009.Therisehasbeenasswiftandunusualaswasthecrash.TheNiftyhassurgedover35%fromMarch lows even as the number of Covid-19 cases in the country have jumped from 500 to over 6 lacs during the period. ValuationswerenearGFC(2008)troughsinlateMarchandinvestorpositioningwasreflectingextremepessimism.Atthe same time, economic data globally suggests continued pick-up from Mar-April levels. This has partly been a function of economies reopening and partly owing to the unprecedented policy support that has come through globally on both monetary and fiscal fronts. Optimism on a vaccine is high too with several competingcandidates.
Theunprecedentedliquidityhasdirectlyhelpedfinancialmarketsaswell.Whileequitieshavedonewell,safehavenssuch as Gold and US treasuries stay well bid too indicating the prominent role liquidity has played in lifting all boats. Within equities, the rally has been broadening with small caps participating as well. Another interesting feature of this rally has been the so called “Robinhood” effect, wherein the participation by retail investors has substantially increased through low cost online brokers. Bouts of volatility are likely as the divergence between markets fundamentals and macro fundamentalsgetsaddressedwiththelattercatchingupalbeitmuchgradually.USM2growthisalreadyatamulti-decade high. The Fed has stayed dovish with respect to forward guidance. Expansionary fiscal policy is here to stay as we believe governments globally will resort to Keynesian economics to create low end jobs through infrastructure spending in the wake of rising inequality and socialpressures.
The combination of unprecedented monetary and fiscal stimulus globally should prove reflationary on the other side of the crisis. Markets believe that the worst on the economy is behind. However, the zigzag on the health crisis will likely continueinthenearterm.ContinuedriseinnumberofcasesinIndiaandinothercountriesincludingtheUSisconcerning. While this may not result in widespread lockdowns anymore, it could slow down the reopening process and delay the return to normalcy. The second order impact of delayed normalcy on creditworthiness of stressed borrowers and hence healthofthefinancialsystemisakeyrisk.Additionally,therearelong-termchangesthatthecrisiswillbringaboutaround consumer behaviour, technology, healthcare, policy, geopolitics, supply chains, and so on. These disruptions will shape the course of the economy over the next fewyears.
Itisbecomingprettyevidentthatthecurrentcrisishasonlyacceleratedtheshifttowardsamulti-polarworld,challenging theunquestionedhegemonyoftheWest.Asglobalpowersracefordominanceandnewcoalitionsemerge,EMslikeIndia shouldenjoyincreasedbargainingpowerinthenewworldorderifweplayourcardsright.Whilewecommandastrategic location on the globe, India is particularly well placed to leverage its position for two more reasons: one, its 1.3 billion population makes it a large market and two, the same population also serves as a rich source for bigdata.
InaworldwhereAIandrelatedtechnologiesdisrupttraditionalsourcesofcompetitiveadvantageandarelikelytobevital intheraceforglobaldominance,wemustleverageouradvantageondatatothefullest.Highmobileanddatapenetration, NPCI and a robust payment infrastructure, widespread coverage of Aadhaar cards, initiatives such as Health Stack, etc point to India’s preparedness on the digital side even as we must aspire to execute much better. In addition, with a democraticset-up,ruleoflaw,andIPprotection,Indiaofferstrustandtransparency.Buildingstrengthontechnologymay take time, but data surely is a strength and through right execution we can forgeahead.
The right policy mix is critical. We need to create a robust ecosystem to nurture entrepreneurs. Start-ups in India have been funded by VCs or PEs that have largely relied on foreign money, as domestic investors have stayed away. We now boast of foreign exchange reserves in excess of US $500 billion. Time may have come to think about our own sovereign fund to fund innovation and provide the much-needed risk capital. Similarly, we need to incentivize the domestic pool of savingsintosuchventures.WealsoneedtocreaterightincentivesforIndiantalentabroadtoreturnandhelpinpowering ourdigitaltransformation.Momentsliketheseleadtoextraordinarychanges.SARSprovedtobeaninflectioninAlibaba’s journey in China. Covid-19 is a similar inflection point in our journey, and we must make the most ofit.
The Covid-19 crisis is likely to accelerate deglobalization and localization in manufacturing, and at the same time lead to increased globalization on services. Both are trends that India is well placed to capitalize on. On manufacturing, we need togowithfullmight,throughpolicy,capitalandinfrastructuresupport,tohelpindustriesthat wewanttoprioritizeaswe
makeinIndia,andforIndia.Wehavebecomecompetitiveoncorporatetaxrate.WehavecreatedsuccessstoriesinAutos, Pharma, and Light industrials. We are now doing the same in Chemicals and Electronics. However, we still have external dependenciesinboththatneedtobeaddressedandlocalizedtotheextentpossible.Bringingdownthecostoffactorsof production, a focus on innovation and a business-friendly environment are critical to realize our truepotential.
In contrast to the deglobalization narrative, services could actually witness more globalization owing to the Covid disruption. The west has many Indian doctors, professors, and tech professionals. Earlier they had to physically relocate afterobtainingaVisa.Todaywithincreasedvirtualization,theycanbemoreeasilyemployedwithouttheneedofphysical movement. More and more firms are adopting Work from Anywhere. What stops a teacher in India to impart education to kids in the US through a virtual classroom or a doctor to administer telemedicine to a patient anywhere. The whole offshoring theme that has helped services exports from India in sectors such as IT can go a notch higher as a result. This has the potential to create millions of services jobs as virtual workplaces allow greater global person-to-personconnect.
In the near term, however, we still need to see through the challenges on both the health aspects of the virus spread as wellastheeconomicslump.WithFY21GDPlikelytolooklikeFY19GDP,debtprofileisboundtoworsen.Togrowourway outistheonlywaytogoevenasthatmeansfiscalexpansioninthenearterm.Monetarypolicyhasstayedaccommodative and real rates are negative. Interestingly, continued monetary accommodation and low real rates could revive demand for real assets. Price correction along with low rates can do the trick for the real estate sector, which in turn has the potential to pull the economy out of itsslump.
On fixed income, even as there is some more room for yields to fall, the juiciest period for government bonds is likely behind. While the curve stays very steep, continued fiscal pressures provide resistance. Credit spreads have shrunk but remain high due to economic uncertainty and risk aversion. FPIs have been heavy sellers in Indian debt markets. This makes India’s inclusion in global indices critical, failing which RBI will have to absorb a large part of the supply. Further, policy rates may not have much room to fall as risks to medium term inflation are weighed against the near-term disinflationary impact of the crisis. Forces such as rising protectionism and tariffs, supply disruptions owing to Covid, geopolitics, and supply chain reorientations, rising labour cost due to reverse migration and a continued surge in global M2 growth have the potential to revive inflationary pressures as and when demand returns.
On equities, we stay bottom-up. Black or grey swans have happened with striking regularity, starting with the dotcom crash at the turn of the century, the ghastly 9/11 terrorist attacks, a once in decades global financial crisis, the sovereign debtcrisisinEurope,EMcrisisafterthetapertantrum,Brexit,adecadeplusofpersistentdeflationeventuallyculminating innegativecrudeoilprices,demonetization,andofcoursetheonce-in-a-centurypandemicinCovid-19,allinaspanof20 years. This underscores the need for robust risk management as being integral to investment process, and at the same time highlights the need to pick companies and managements that can navigate the unknown-unknowns that have occurred all toofrequently.
This is a momentous point in our journey. Inflection points such as these have the potential to make or break nations, institutions,andorganizations.Thewinnersofthefuturecanlookverydifferentfromthewinnersofthepast.Inthenear term, risks around a potential second (or rather continued first) wave and consequent delayed return to economic normalcy amidst heightened investor optimism may continue to bring bouts of volatility. The best way forward is to identify these winners and stay invested through thechaos.
