A second wave of virus in the Western world has become a reality. This along with failed negotiations on fresh US fiscal aid and the uncertainty around US presidential elections have acted to keep financial markets volatility high. This led to markets continuing to trade choppy for a second consecutive month.
The news locally however was better with the reopening led improvement in economic activity continuing and more importantly Covid infections finally showing signs of moderation. Corporate results too have been better than expectations so far driven by cost control and beat from banks. Yet, given the muted domestic flows, Indian markets continue to be driven by foreign flows and should follow global trends in the near term. Globally, a potential double dip in growth owing to fresh Covid-induced lockdowns and fading fiscal support is a key monitorable.
However, the most keenly awaited event in the near term stays the US Presidential election this week. The outcome assumes much greater importance in the wake of a more prominent role for fiscal policy and fragile geopolitics. For corporate America, likely increase in tax burden, regulation and labour costs may dampen margins. Yet a supportive demand environment should offset some of these pressures.
Global reflation should help too as MNCs derive a chunk of their earnings from outside the USA. For EMs, global reflation and consequent weaker dollar should both be decisively positive.
A reflation will not only help equities as an asset class through earnings revival but it also has implications for the complexion of equities that deliver. Just as there is inequality at an individual level, there has been increasing polarization in stock markets too with a select few stocks becoming a disproportionate share of overall market cap. These stocks have benefitted from lower discounting factor owing to their longer duration cashflow profile and stable earnings or have been on the right side of technological disruption. With growth becoming more broad-based, this polarization should reverse. Looked through other lenses, this would mean reversal in polarizations of value versus growth, small caps versus large caps, cyclicals versus defensives, and also importantly emerging markets versus developed markets.
For India, a global reflation could just be the icing on the cake. We appear to be preparing ourselves well for sustainable and inclusive growth. On one hand, we have done well on empowering masses through various social initiatives such as sanitation and cleanliness. On the other, we have undertaken a host of legislative reforms to incentivise the private sector, labour and agri reforms, tax reforms, insolvency code and production linked incentive schemes to incentivize manufacturing, amongst others. Incrementally, we need to stay focussed on execution - expanding our institutional capacity on judicial and administrative fronts, infrastructure creation, ensuring transparency and sanctity of contract.
While fiscal capacity is constrained, given the savings glut, local as well as global, we must not underestimate our ability to fund a credible growth plan. Once set in motion, the private sector will get in by itself. The private sector on its part must respond with more innovation and strong focus on ESG to ensure sustainable growth for all stakeholders.
On the monetary policy side, the RBI has been aggressive and unconventional in the crisis. Right from ensuring abundant liquidity and providing aggressive rate cuts to unorthodox measures like Operation Twists, open market operations and easing of prudential norms, the RBI has not left any stone unturned in supporting growth, while government’s credit guarantees have helped provide a multiplier effect.
With RBI staying accommodative and with the moderation in virus spread leading to continued pick-up in economic activity, improvement in transmission should continue, which should further aid economic and corporate activity. In fact, 90% companies in our universe are witnessing earnings upgrades.
The recovery so far may have been pent-up demand led and how consumption and savings patterns eventually shape up in the aftermath of the crisis and whether corporates and consumers continue to stay cautious for long is yet to be seen. If anything, the nature of the recovery so far has indeed been ‘K’ shaped, with widely varying fortunes across sections- rural vs urban, goods vs services, formal vs informal and so on.
A fiscal boost is a must to kickstart the long overdue economic and earnings cycle in India. A decisive reflationary shift in global policy can be an added tailwind. Real estate, which has an important bearing on the economy owing to the high multiplier impact, is showing initial signs of recovery, which is encouraging. Private sector balance sheets are in better health to capitalize on growth opportunities as they present themselves.
We are constructive on duration in fixed income portfolios while keeping a close watch on inflation, fiscal situation, and global environment. We are anxiously excited on equities as we believe the next earnings upcycle may be near.
Navneet Munot is the CIO of SBI Mutual Fund. The views expressed in this article are solely of the author and do not necessarily reflect the views of Cafemutual.