Explained: optimism around the markets, but some factors could derail the recovery

The formidable recovery in the stock markets after falling 36% between February and March 23, 2020, surprised many as it coincided with the spread of the coronavirus, and recently with the emergence of a more potent mutant form of the virus at the time. even where the promise of a vaccine since November had given hope for a rapid return to normal.

As we move into 2021 and Indian regulators deliberate on approving the use of Covishield – the Serum Institute of India’s version of the AstraZeneca-Oxford vaccine – there is a sense of optimism among the public, investors. and market players. Sensex (along with Nifty) is up over 80% from year-low on March 23, and 15.7% on calendar year, better than 14.4% in 2019 and much more than 5.9% in 2018. Who would have thought in March, 2020 would end with more than 15% positive returns for investors.

However, the national and global economic recovery, which forms the foundation for sustainable market growth, is still a work in progress amid concerns in various respects. We have to be cautious about expectations from 2021, bearing in mind that the 2020 recovery was driven by excess liquidity and was not based on the fundamentals of the economy. If that money were to come back, it could lead to a correction. There are several factors or risks that the market is likely to face this year.

Inflation

The biggest problem the market may have to navigate is a possible reversal in the flow of funds. As countries around the world have near-negative interest rates, resulting in an influx of money to emerging markets including India, the market feels like a mere signal of rising prices. interest rates can potentially derail this influx of foreign currency and reverse the trend. trend.

“Another relief package from the United States will impact inflation. While the immediate impact would be more inflows, this will eventually lead to higher inflation and could lead central banks to raise their interest rates … We have to be vigilant about this ” said CJ George, MD, Geojit Securities.

Experts say that if no country can afford to raise interest rates significantly, as this would risk reversing growth at the moment, a change in position could lead to capital outflows from emerging markets to developed economies.

While REITs (foreign portfolio investors) can afford to take risks, many feel sensitive to external interest rates. So every time the United States signals that it is going to move from an accommodative policy to a policy of tightening monetary policy, the REIT money will start flowing back into U.S. Treasuries.

This is a major concern this time around, as the most important factor that drove the markets up was the abundant global liquidity. Between April and December, REITs injected a net of Rs 2,18,291 crore into Indian stocks, the highest of all years. In fact, entries in November and December alone amounted to a record Rs 1,22,373 crore.

As a report by Motilal Oswal Financial Services notes, “This would not have been possible without the world’s central banks resorting to unprecedented synchronized liquidity over-multiplication and lowering interest rates to historically low levels, ensuring the easy money availability.

Even the governor of the RBI, in his monetary policy statement in December, said that, as investors left the safe-havens of US Treasuries in search of higher yields, “surges in capital flows poured in. in India”.

Factors such as rising inflation and a change in the direction of interest rates by central banks, however, can lead to a reversal of FDI flows and have a negative impact on stock markets.

Nilesh Shah, MD, Kotak Mahindra AMC said that withdrawing the stimulus prematurely can create a significant problem for economic recovery in all countries, and so it will be very important to see when they start doing so. As everyone looks at the large listed entities to conclude that there is a recovery, Shah said, “What if the small, medium and small businesses, which are the main job creators, are still struggling. If so, jobs will remain affected and economic demand will suffer as well. In order for us to have a sustained recovery in the long term, we need a recovery across the entire segment of the economy and not just a few large companies ”.

Vaccination speed

While the rise in the stock market due to abundant liquidity and flow of funds was the story of 2020, it will need to be replaced by one based on economic recovery and growth – consumer demand, private sector investment. and job creation, among others. This will be critical not only for the growth of GDP and corporate profits, but also for the long-term sustainability of equity investments, by both domestic and foreign investors.

And for that to happen, India will have to show the speed of its vaccination program and the effectiveness of the vaccine, as this will give confidence to the masses, businesses and foreign investors.

“The greatest risk is linked to the vaccine itself because there is a lot of doubt. The market assumes the vaccine will reach everyone, but what if there is a problem with them reaching everyone or containing mutations. All the assumptions that normal economic activity will continue are based on effective vaccination and getting people back to normal life, ”Shah said.

George agreed, “Our ability to immunize a large population in record time will be the engine of economic growth.”

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Many believe that the pace of vaccination will give people the confidence to spend and invest. This would result in demand generation and revenue growth for businesses (which has been lacking in the past two quarters), and reflect economic growth and recovery.

“We don’t need to reach a large number of people, only the speed of vaccination will give confidence and the economy will jump from the lower base,” said George.

However, any hiccups in the immunization schedule would reduce market confidence and the ability of the economy to rebound faster.

The Covid-19 threat

As a vaccine is in sight and regulators in India deliberate on approving Covishield, the emergence of a more potent virus variant from the UK has reminded the world that the threat is still very real and can potentially delay the return to normal. As countries started restricting air travel to the UK again, announcing lockdowns and curfews, markets have seen a sharp correction and they remain under threat.

A country’s ability to control the spread of the virus and keep an eye out for new mutant forms will be critical to its recovery process. The country which is in a position to demonstrate this better will see a more rapid return to normal; however, a country that fails to do so could take a roller coaster ride.

Market players believe that if the next phase of the spread of Covid-19 is not severe and vaccination is effective and efficient, the economy will be back on track faster.

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