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

The astonishing recovery in stock markets after a 36% drop between February and March 23, 2020, surprised many as it coincided with the spread of coronavirus and the recent emergence of a more powerful mutant form of the virus even when the promise of a November vaccine the hope of a speedy return to normalcy.

As we enter 2021, Indian regulators are deliberating on approving the use of Covishield – the Serum Institute of India version of the AstraZeneca-Oxford vaccine – there is a sense of optimism in the public, investors and market participants. Sensex (as well as Nifty) grew by more than 80% from the low of March 23 and by 15.7% in the calendar year, better than 14.4% in 2019 and much higher than 5.9% in 2018. Who would have believed in March, 2020 will end with positive returns of over 15% for investors.

However, the internal and global economic recovery, which underpins sustainable market growth, is still a work in progress amid concerns about various accounts. We need to be cautious about expectations for 2021, given that the 2020 rally was driven by excess liquidity and was not based on the fundamentals of the economy. If that money should be returned, 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 could face is a possible reversal of cash flows. As countries around the world have negative interest rates, leading to the flow of money to emerging markets, including India, there is a market feeling that a simple signal of rising interest rates can potentially derail this foreign cash flow and reverse the trend.

“Another aid package from the US will have an impact on inflation. Although the immediate impact would be more inflows, it will later lead to higher inflation and this may lead to higher interest rates by central banks … We need to pay attention to the same thing, ”said CJ George, MD , Geojit Securities.

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

While REITs (foreign portfolio investors) can afford to take risks, many believe that they are sensitive to external interest rates. So whenever the US signals that it will move from a position of accommodation to a tightening monetary policy, REIT money will begin to move back into US treasury bonds.

This is a major concern this time around, as the biggest factor that led to the growth of the markets was ample global liquidity. Between April and December, IFPs accumulated a network of 2.18.291 billion lei in Indian shares, the largest in any financial year. In fact, the entries only in November and December amounted to a record of 1.22,373 million lei.

According to a report by Motilal Oswal Financial Services, “this would not have been possible without global central banks resorting to unprecedented synchronized excess liquidity and reducing interest rates to historic lows, ensuring the availability of easy money.”

Even the RBI governor, in his December monetary policy statement, said that as investors exited the safe havens of the US Treasury in search of higher returns, “increases in capital flows flooded India.”

However, factors such as rising inflation and a change in the interest rate position by central banks can reverse the flow of FDI and have a negative impact on stock markets.

Nilesh Shah, MD, Kotak Mahindra AMC said that the premature withdrawal of the stimulus can create a significant problem for the economic recovery in all countries and therefore it will be very important to see when this will start. As everyone looks at the large listed entities to conclude that there is a recovery, Shah said, “What if smaller companies in small and medium-sized businesses, which are big job creators, are still struggling. If this is the case, jobs will remain affected and demand in the economy will suffer. In order for us to have a sustained long-term recovery, we need revitalization on the entire segment of the economy and not just on a few large companies ”.

Vaccination rate

While the growth of the stock market due to ample liquidity and cash flows has been the story of 2020, it will have to be replaced by one based on economic recovery and growth – consumer demand, private sector investment and job creation, among others. This will be essential not only for GDP growth and corporate earnings, but also for the long-term sustainability of equity investments, both by 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, because it will give confidence to the masses, companies and foreign investors.

“The biggest risk is the vaccine itself, because there are a lot of doubts. The market assumes that the vaccine will reach and reach everyone, but what if there is a problem that reaches everyone or contains mutations. All assumptions that normal economic activity will continue are based on effective vaccination and people returning to normal life, ”Shah said.

George agreed: “Our ability to vaccinate a significant population quickly 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 increased demand and revenue growth for companies (which has been lacking in the last two quarters) and would be a reflection of economic growth and recovery.

“We don’t need to reach a large population, only the speed of vaccination will give confidence, and the economy will jump from the bottom up,” said George.

However, any hiccups in the vaccination program would reduce market confidence and the economy’s ability to recover faster.

The Covid-19 threat

While a vaccine is in sight and regulators in India intend to give Covishield approval, the emergence of a more powerful virus variant in the UK has reminded the world that the threat is still very real and may delay a return to normalcy. As countries returned to restricting air travel to the UK, announcing blockades and shutdowns, markets witnessed a sharp correction and remain in danger.

A country’s ability to control the spread of the virus and keep up to date with new mutant forms will be essential to the recovery process. The country that is better able to prove it will see a faster return to normalcy; however, a country that fails to do so could take part in a roller coaster ride.

Market participants 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.

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