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Pace of flow into equity unsustainable as investors cut leveraged positions

Topics Markets | Market Outlook | Sensex

Jitendra Gohil, head of India equity research at Credit Suisse Wealth Management, India
Foreign portfolio investors (FPIs) are selling and cutting their exposure to emerging markets (EMs) given virus fears and crash in oil prices, as they are unwinding their aggressive bets and India is no exception.

Generally when the oil price crashes, India tends to relatively outperform peers. This time the situation is bit murky for India given weak macro already. Brent crude oil at $30/barrel means a nearly $42 billion (1.4 per cent of GDP) boost to India’s economy, according to our macro strategist. This can help government revenues as government may retain most of the gains by increasing taxes. However, the overall consumption slowdown and tax revenue loss may offset some benefits. So far the domestic equity flows have been robust, but given challenging macro conditions and unwinding of leverage positions, sustenance at this pace looks difficult.

Our macroeconomics team has cut India’s GDP forecast for financial year 2020-21 (FY21) to 5.2 per cent and I feel there could be some more downside to this if the situation is not controlled over the next month or so. In terms of corporate earnings, we are already below consensus at around mid-teen levels for the next two years. I would rather wait for more clarity during the upcoming earnings season before jumping on to adjusting our below consensus earnings estimates.

Fast moving consumer goods (FMCG) companies could see benefits of pre-buying and the lower oil price environment; on the other hand, we will be keenly observing the performance of banks and financial institutions where the stress might build up in the MSME and Retail books as well. On the positive side, the Rabi sowing has been good and with high water reservoir levels, harvesting could be good this quarter, which may help rural economy to some extent.  

So, what will the Reserve Bank of India (RBI) do then? We expect the central bank to cut rates and think that the wait-and-watch approach is good at this point in time. The RBI specifically mentioned about taking necessary policy actions at an appropriate time and this is prudent given the evolving situation.

Currently, the sentiment is so weak that cutting rates will not help in the near term. In fact, in the US, too, despite the US Federal Reserve announcing $700 billion quantitative easing (QE), the market sold off. We believe the sentiment will turn once we see virus infection numbers peak and start to recede or we find some cure or vaccine, etc. Monetary stimulus will help to address liquidity situation and sentiment will improve only with a lag.

That said, the economic impact of travel restrictions and quarantine measures is likely to be huge. Travel restrictions can lead to a significant impact on the travel and tourism sector, which is about 9 per cent of India’s GDP and employs more than 4 crore people. Banks and financial institutions may struggle for liquidity and see higher cases of NPAs, especially in the retail and MSME sectors.  

Globally, too, June quarter will likely see negative GDP growth that is likely to continue in the September quarter. These two consecutive quarters of negative GDP growth will lead to a significant deterioration in earnings and cash flows for companies.

What's in store for equity investors?

After this precipitous fall in equity markets, we might see some short covering. However, we still do not believe the equity market has found a bottom and it is still not a time to bottom fish. Over the next three to six months, once the virus is bought under control and the oil price stabilises, we may see opportunities. But as of now, we are advising our clients to cut leverage and diversify their portfolios. Within India we prefer fixed income – only high quality bonds – over equities as we believe the risk-adjusted return is skewed towards the former.

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