In the hunt for yield, the Indian investor is betting on equity. But this is the time to preserve capital, not to risk it
There is a disconnect between the Indian household’s opinion of the nation’s finances and that of its own. As long as individual spending is curtailed by anxiety, the economy cannot recover
NEW DELHI :
When the reality of covid-19 began to hit India this March, our equity markets tanked. The day before India’s national lockdown was announced, the Nifty hit a four-year low of 7,584, losing almost 40% from its January peak of 12,430. Since then, we have seen a slump in manufacturing activity, a migrant labour crisis, a drought of property transactions, and the hollowing out of labour-intensive services, from hospitality to beauty salons.
Yet, the Nifty has climbed the wall of economic worry, and is now at 11,132.
This upward movement is not without logic. India’s favourite pockets of investment are no longer attractive—bank fixed deposits return less than inflation, and real estate has been depreciating for several years.
In the hunt for yield, the Indian investor seems convinced that equity is the best bet; staying away from shares today would be an opportunity lost forever—this is classic FOMO (fear of missing out). As a committed equity investor, however, I am less than convinced. The pain to the economy is not known, not predictable, and I’m happy sitting the next few months out. Let me explain why.
Across the world, investors are deflecting fear, and responding to cheap liquidity by buying stocks, driving major indices towards their March highs. The US tech index, the Nasdaq, in fact, hit an all-time high earlier this month. Indian equity has not been as favoured by foreign investors: except for the month of June, they have been net sellers since March. Flows into equity mutual funds have also been dropping, so it would seem that individual investors have been driving our markets up.
Online brokers report a surge in new trading accounts, and 3 million new demat accounts have been opened since February. Such a flood of newly minted equity traders is always a warning sign. “Recency" is a powerful force, and when you see unprecedented returns of over 40% in just over 4 months, equity trading seems highly attractive.
The problem is compounded by a huge disconnect between the Indian household’s cheerful opinion on the nation’s finances, and a glum view of its own. Since even economic experts can’t agree on the first, one should pay more regard to how households plan their own budgets. As long as individual spending is curtailed by covid-19 anxiety, the economy cannot recover.
The big picture
As covid-19 has marched across our nation, the consensus on gross domestic product (GDP) growth rate has dropped steadily. In April and May, the mainstream view was of low but positive GDP growth.
Meanwhile, two economists of long standing sketched a bleak picture—one was Pronab Sen, who had been India’s chief statistician; the other, Shankar Acharya, had been chief economic adviser. Each sketched a range of outcomes, dependent on government response, the extent of lockdowns, etc., but a fair representation would be to say that they were in the range of -10% to -12%.
Mainstream commentary took a long time to accept that Indian GDP was shifting into reverse gear. Reality, however, does not recognize cognitive inertia. The lockdown took its toll on both demand and supply; the “atmanirbhar" package held out fiscal aid of barely 1% of GDP; and our government was putting the brakes on new project announcements.
By June, the broad consensus on GDP growth settled in the range of -4 to -5%. On 16 July, credit ratings agency ICRA Ltd became the first major institution to flash a GDP projection close to -10%.
Never in living memory have GDP projections shifted so sharply in such a short time. The primary reason is that we have been unable to predict the progress of covid-19, and hence of its economic impact.
Official projections of “flattening the curve", and “no community transmission", have stood at odds with low testing rates, poor tracing and the exponential curve of new cases. The second is the paucity of macro-economic data. Covid-19 has made data-gathering more difficult, but our statistical systems have been weakening for several years now, with a strong bias to suppressing weak performance data.
For instance, GST collections for June, at ₹90,000 crore, were widely broadcast, as they showed a massive recovery from April and May, and were only 10% below the June 2019 number. But the GST regime had allowed April and May dues to be delayed into June, so the month’s gross collections were not a meaningful indicator of the month’s economic activity.
“No News" may be a good public relations (PR) strategy, but a modern economy requires a steady flow of data. In this data vacuum, each of us tries to construct a picture of the economy from a highly individual mix of what leaps out at us—corporate data, sectoral production, fiscal indicators, and anecdotes.
In the recent ICRA presentation, for example, the massive slump in new project announcements, from ₹3.5 trillion. in Q4 of FY 20, to ₹0.6 trillion in Q4 of 2020, stood out. This extreme reluctance to commit to growth signals uncertainty about the near future, and the need to shore up balance sheets. State governments, ICRA notes, are going to be constrained by extreme weakness in tax collections, and the cap placed on their market borrowing.
The Google mobility tracker has become a widely deployed window into our responses to the progress of covid-19. Indicators for Indians returning to work, or to recreation and public transit, had improved steadily from April to June. Then, as lockdowns returned to several cities and states, we began to see mobility level off, then dip.
At the state level, it is easy to see how human activity levels mirror regulatory measures; these, in turn, are triggered by the arc of cases. India is not alone in this regard—the US has seen sharp regulatory reversals in states like California, Texas and Florida, where the spirit of summer fun led to a surge in cases.
These reversals and potholes in the covid-19 path are proving difficult to negotiate. Countries like Australia and China have seen unexpected outbursts of the disease. While governments in these nations are able to come down hard on any such incidence, our public health mechanism is much less responsive. This is bound to trigger uncertainty in the economic sphere.
Stories of consumption
The airline business clearly shows the link between health concerns and consumption. Domestic flights were resumed on 25 May, and the number of daily passengers picked up smartly. But since early June, the traffic has levelled off at between 60,000 and 70,000 passengers a day, which is less than 20% of the daily volume in 2019.
As long as quarantines are in place, and the fear of covid-19 is in place, many forms of consumption will be restrained.
Consider the McKinsey Global Institute’s tracker of household attitudes towards personal finances in the time of covid-19. In the third week of June, a little over 50% of respondents were optimistic about a quick recovery in the economy. The level of optimism was the same as in March, despite 3 months of pain.
But if you move from macro-projections into personal decision-making, you see a completely different picture: 67% of respondents say they are cutting back on their spending, and 58% say their income has been negatively impacted by covid.
So far, India has shown no ability to arrest the spread of the pandemic. Early on, the nation’s mood was largely of denial —it is a winter disease, Indians have natural immunity etc. As cases mounted, several medicines or treatments were briefly seen as silver bullets, especially hydroxychloroquine (HCQ) and remdesivir. No silver bullet has appeared, but the rapid exchange of global experience has led to better treatment protocols.
Global mortality rates have steadily declined, and the lower age profile of Indians has moderated our death toll. But the pandemic shows no signs of peaking, and I suspect we will see hundreds of local waves of lockdown fatigue, spikes in illness, and consequent curbs on movement and activity. A vaccine will arrive eventually, but we don’t know how effective it will be, how many doses will be required, and how long before it can be distributed to 1,300 million Indians.
The investor strategy
So, till the pandemic fades, how should investors deal with this combination of economic uncertainty and low-returns on bonds and bank deposits?
When low risk offers low returns, it is true that you need to take higher risk to make higher returns. The shift is necessary, but it is not sufficient. The very definition of high risk is unpredictable outcomes. When we say climbing Mount Everest is high risk, we mean that many climbers will not reach the peak. Many will turn back, a few will fall sick, some will suffer accidents. Similarly, equity returns will always throw up a wide spectrum of losses and failures. Some shares will become multi-baggers, and others will lose 90%.
The best way to deal with risk is to acquire skills and knowledge that reduce that risk. If you are planning to climb Mount Everest, it is vital to learn rock-climbing and ice-craft, to build your strength and stamina, and try your skills on a less risky peak.
Similarly, successful equity investors understand balance sheets, corporate finance, industry structure, the quality of leadership, and macroeconomic forces. When you buy a share, someone is selling it, and it’s worth asking—“What makes the share unattractive to the seller, but valuable to me?". If you have a clear answer to this question, coming from a specific insight, or a detailed understanding of the business, go for it. If not, you’re relying on a broad sentiment to make money for you.
In growth economies like ours, this popular sentiment has been rewarding for long periods, when enough money was being made by all. But when there is a huge fog of uncertainty around our economic prospects, it’ll not be enough.
As long as a recovery from covid -19 is not in sight, I’m not betting on the economy. If a snowstorm broke on Mt Everest, I’d be happy to be sipping soup in base camp.
For the average investor, this is the time to shelter in the safety of bank deposits and government bonds. When the pandemic clears and the economy gets back on track, I will venture back onto the slopes.
Perhaps I won’t be the first out of my tent, but the Indian eco-system will always throw up promising companies, listed or unlisted. Pronab Sen recently said, “It’s unlikely that we will see only one turning point in the economy" as it deals with covid-19. So, it makes absolute sense to sit out the volatility. This is the time to preserve capital, not to risk it.