Equity Markets Round Up: May 2020 Globally, equity markets continued their strong recovery from lows reached in late March despite escalation in US-China tensions as the US government threatened to delist Chinese companies and China’s signing of HK security legislation. This was led by extremely easy financial conditions, gradual opening up of the economies around the world and a flattening of the COVID curve in developed countries. The number of cases in emerging economies however continue to rise at an increasing pace in terms of absolute numbers. The MSCI World index, which tracks developed markets (up 4.6% during the month) easily outperformed the MSCI EM (USD) index (up 0.6% during the month). India however underperformed the MSCI EM with MSCI India (USD) down 2.7%.

The strong risk on trade continued during the month and equity markets were relatively calmer (the India VIX was down 11%) during the month. Crude (Brent) price rallied nearly 40% and commodity prices were up. The London metals index of six key (non-ferrous) industrial metals was up 3.3% during the month.

One area where the risk on trade manifested itself was in the price movement of high yield (or junk bonds) in the US market. During the month, the US high yield bond index was up 4.4% while the high-grade bond index was only up 0.5%. According to an article, the junk bond funds in the US have had some of their strongest daily inflows ever in the past month.

For Indian equity markets, May was a month of two halves, correcting in the first half on a somewhat disappointing fiscal stimulus package and rallying in the second half in line with global markets. The package, so far as it related to small businesses, provided for guarantees for loans, rather than direct support. There were however increased spends on NREGA and greater support for power utilities pursuing reforms.

Further reforms and support were announced in areas of defence production, agriculture, and coal mining. States pursuing reforms can borrow more from the markets (though all states can unconditionally borrow an extra 0.5% of GSDP). The union government also announced an additional borrowing of Rs. 420,000 crores for FY 21. Depending on the growth in nominal GDP and the shortfall in revenue, the fiscal deficit as a percentage of GDP could be in the range of 6.5% of GDP for the centre.

Both mutual fund and FPI flows into equity were positive for the month. FPI flows were positive after three months of continuous outflows. In an intra policy move, the MPC cut the repo rate further by 40bps to 4% while maintaining an accommodative stance. The RBI also extended the moratorium period by 3 months to 31st August factoring in the lockdown extension. Interest accumulated on working capital facilities for 6 months of moratorium has been allowed to be converted to a term loan.

The government has gradually permitted an opening up of the economy. According to Credit Suisse estimates, restrictions now impact only about 5% of the GDP while they impacted 68% of the economy in the first lockdown. Further, they estimate that in the last week of May, power demand was almost normal and down only 2% YoY. Credit card spends in mid-May had already reached 60% of normal spends and would likely be a higher number now.

After a surprise upgrade in Nov-2017, Moody’s downgraded India’s rating to Baa3 (last rung of the investment grade) in line with S&P and Fitch. However, its decision to keep the outlook as ‘negative’ could also lead to other agencies to change their ratings to ‘negative’ outlook from ‘stable’ currently.

Outlook The valuations for the broad market are reasonable though there is substantial divergence in the valuation across companies. Markets are focusing on those companies which are expected to emerge in a relatively better position due to their dominant position in their industry, balance sheet strength and early resumption of normal operations.

Companies are finding that their operating costs have gone up due to the need to implement social distancing in their operations and as labour availability is somewhat reduced. As a result, prices of manufactured products are unlikely to fall. As the economy opens, the markets will track consumer behaviour for signs of any changes in their consumption pattern.

We think the economic recovery will be gradual as a result of caution on part of consumers (at least initially), weak business balance sheets for some companies and the possible lingering threat of a ‘second wave’ of the infection. The RBI has already cut rates sharply, and in our view, the incremental value of rate cuts to the real economy is relatively low, especially as the financial system is cautious about expanding credit.