Despite the uncertainty around the US Election results, the stock markets in India have risen more than 1,340 points in two days. Former Vice President Joe Biden currently enjoys a slender lead over the incumbent Donald Trump but with the Trump campaign legally challenging the results in many states, the US Election is far from a foregone conclusion.
According to experts, the likelihood of a Democratic presidency and a Republican Senate will be better for the global economy as well as the COVID-19 pandemic response. "What was scaring the markets was that if there was a Blue Wave and the Democrats controlled all three; the House, the Senate and the presidency, there could have been a shift towards the progressive policies," Ajay Bagga, private investor and Independent Director told BOOM.
"Now, Joe Biden will also be bound by getting his proposals through Senate and more than anything, the Republicans will return to the roots of being austerity economists and being more pro-capitalism. Historically, a Democrat president with a Republican Senate has tended to be the best performing for the US markets and by correlation for the Indian markets," Bagga added.
However, G Chokkalingam, Founder and CEO, Equinomics, warned investors against jumping the gun before the complete results of the US elections were in while backing industry leaders in the market.
"You need to wait till the complete certainty comes from the US election. Because now market believes whatever is the result, it is positive. That may not be the reality post selection of the President. Secondly, the biggest risk is in 2021. If the economy is correcting 10% this year, and next year, it is going to recover only 5% to 8%, the absolute output in 2021 calendar year will be less than what we saw in 2019. If you go for 100% value stock, then you may be regretting for long," Chokkalingam said.
Edited excerpts of the interview follow
Govindraj Ethiraj: Are Indian markets adopting or following cues other than what's happening in global markets and therefore the United States? Or are we influenced by the United States to the extent that because those markets don't seem to be affected too much by the electoral outcomes and therefore, we are not to? Ajay, why is this happening?
Ajay Bagga: It's a combination of three or four factors, Govind. One is that right from March onwards, we had a very strong monetary stimulus and a global fiscal stimulus also. So nearly $20 trillion have been injected into the global economy. So, we have seen a V-shaped recovery in the global economy. So last week, we saw the PMIs, which is purchased manager index, it gives an idea of both manufacturing and services. The manufacturing PMIs in China, in Europe in US and in India, were at multi-decade highs. India had a 17 year high of PMI at 58 levels, anything above 50 years, meaning strong expansion, and we had level at 58. So, the economy is recovering from COVID. It has not reached the pre COVID levels, but the direction is strong. So, markets being forward-looking are welcoming that.
Second, the hit on the bank's balance sheets is not apparently that bad so far. What we were fearing that September would see a huge NPA surge. One is the courts have frozen NPAs as of August 13. But even the commentary from banks is for NPAs not being so bad. So global flows, NPAs not being so bad. Third being that globally, last week, the markets fell 5%, and we had some weakness in India as well.
What has worked in the week of the US elections is that the Democrats don't seem to be getting a blue wave majority. That is, control of the House of Representatives, control of Senate and the presidency. What is looking like is a split mandate where the Republicans might have the majority in Senate or it could be a 50-50 kind of a case. And Joe Biden as the president, what that implies for markets, three big things. One, the tax hikes will be difficult to do. That's a straight 10% to 12% increase in the earning potential next year, because they were planning to hike the corporate rates to 28% from 21%.
Second, the regulatory environment remains benign. And so big IT started, you know, rallying, because you will not see breaking up a big IT at least they are safe for the next two years till the next Senate elections come. And third, very importantly, a Joe Biden presidency will see international trade and international treaties being honored. So, it will be overall better for the global economy and pandemic response will be stronger. So that recovery will be faster under a Biden presidency. Those are a few of the factors.
GE: Mr Chokkalingam, how are you seeing it and how have you seen the rise in the last seven months or so?
G Chokkalingam: If you would talk about last seven months, then you need to mention the fact that March 23 the whole global equity markets got scared due to the pandemic and the lockdown impact. The Indian market lost 52 trillion rupees, 52 lakh crore of market cap by March 23. So, the subsequent six months of recovery, partly due to the connection of this excessive fear in the market, and that was the first phase.
The second phase that is for last one month or two month and particularly for last one week, the fear on the US election is receding particularly in the last few days. The global markets have risen. So, the Indian market, now, interestingly there is a structural change. The correlation of Indian equity indices with US indices now it's almost .95 - .96 in the last six months or one year. This kind of correlation was never seen in the past. So, taking global cues is also quite robust in the latest period.
The third specific reason is the September corporate results. You know, very interestingly, the revenue improvement on quarter on quarter basis is really above expectation. The June quarter had a severe impact on account of the lockdown. So, obviously, there was expectation of improvement in September quarter, but the top line growth was much above the expectation. Then on the bottom line also, it was above expectation, because the cut in the employee cost and fuel cost and also, in the June quarter, a lot of materials prices have crashed. So, many companies have procured those material at a cheaper price in September quarter. So, there was a margin expansion. So lastly, even the economic indicators like a GST collection, fuel consumption, the infection going down. Now, all these have contributed to solid recovery in the last few weeks, in addition to what recovery we saw in the previous six months.
GE: You said that the correlation between India and US about .95% and .96% Are you saying even in 2000, when the when the dotcom bubble happened, we didn't see this correlation?
GC: Very interesting question. In fact, I looked at all this. Whenever there is a crisis in the US market, our correlation increases. Maybe the fear factor is more powerful than the optimistic factor, which a reverse of what happened in China. A couple of years back, the Chinese market crashed very badly, but our correlation weakened to the Chinese market. So, though a lot of people are scared, we did not fall badly.
So, you are absolutely right. You know, the Lehman crisis, dotcom bust and this March 23. And downside, it looks like our people are more scared after seeing what is happening in the US. So, the correlation become much stronger, and recovery, the correlation weakens. Now, for example, year to date, if you see the US market has gone up much more than what Indian market has recovered. So, on the upside, our correlation is slightly weak. And whenever this kind of crisis is that these as you mentioned, there are three crisis we have seen since 2000 January dotcom bust. The correlation jumps to as much as .95 or .96.
GE: Assuming Trump came back, then is there some kind of Reset to Default here, which is continuation, which is not so bad, or is that bad?
AB: It's very good. If Trump comes back very good for the economy and the markets. What was scaring the markets was that if there was a blue wave, if the Democrats controlled all three House, Senate and presidency, there could be a move or a shift towards the progressive or the liberals, which could mean higher taxes, more stimulus, more welfare schemes, and more estate duties, capital gains taxes going up. So, people were afraid of that as far as the markets are concerned. Offsetting that would have been a higher stimulus.
Now their hands will be tied. It is like Obama of 2012 to 2016 where he didn't have the Senate backing. So, he could not do much, he had to move with the senate. So, a minimal common program came up. So now Biden will also be bound by getting his proposals through Senate and more than anything, the Republicans will return to the roots of being austerity economists of trying to balance budgets of being more pro-capitalism. That's what we are going to see.
So, the best outcome for the markets was Trump. Second outcome is this split mandate, and historically, a Democrat president with a Republican Senate has tended to be the best performing for the US markets and by correlation for the Indian markets.
GE: If you look now, at the funds that are coming in, or the money that's flowing into the Indian markets, you talked about a recovery. Now, the recovery is not yet brought things back to what they were pre-COVID. But the exuberance with which the money is coming into the market in some ways exceeds the actuals. But because we've seen such a big jump in the last couple of months, we are celebrating. But this celebration can also have a downside, or what do you think?
GC: I am celebrating with a lot of caution and fear factor. As you rightly said, a lot of things are not coming back to the pre-COVID level. You look at airline and hotel, even pre-COVID level, they were suffering a lot. But the market has been phenomenal. The leader in the hotel industry has come out with a huge loss in September and June, but the market has reverted with a positive gain. Same thing in the airline. In fact, our international air travel Association says they can come back to pre-COVID level worldwide only in 2023. So, I completely agree, the fear is there. The rewards to the market are much more. We have recovered almost 57% from March 24. But economic fundamentals have not improved proportionately. And also, very interestingly, across the world, the concentration is happening in only 5% of the stocks listed. And they are driving up and giving q false opinion that, you know, things are too good. But I don't know how long this can last.
GE: What would you tell investors? How do you separate the exuberance for these stocks versus controlling it from spreading into everything else which usually happens in a bull market?
AB: Building on what you just said, it's a K-shaped recovery. So, this time around, we have learned a new fashion of the economy, where a few concentrated plays have done very well. And asset owners have done very well because asset prices have inflated and the rest of the economy has gone down and is slowly inching back. Manufacturing is coming back. Railways passengers is at two and a half percent. We are talking freight, GST all that has recovered, but there are large sections.
Cinemas, hotels, retail, restaurants which are not represented at all in the stock market or very small representation. So, 30% - 40% of the economy has no representation in the stock market. So, there's a difference between the economy and the stock market. India will recover. If March 2020 was hundred, India will be at hundred in 2022 March 31. So, we would have had two lost years. Now, we would have lost two years of growth and think of how many people have been pushed into poverty as a result. What is the way out?
Huge monetary huge fiscal stimulus. We have been very tight on fiscal because of lack of resources and I would say also lack of imagination. Like you had World War II bonds, you should have been issuing COVID bonds, use the pandemic as a resource with your rating agencies. A very careful government like Germany, has pumped in 40% of GDP as support, especially to SMEs. We have given a credit support and credit enhancement rather than directed. 50,000 - 60,000 crores have come which is very small in our GDP of our size.
So, three things. One, the stock market is fooling you as far as if you think it as a barometer of the economy, it is not. Second, the economy will take two years to recover. Third, they will be a sectoral rotation. Right now, we are seeing banks come back after being -25 for nine months, they are coming back. IT, pharma and the top of the K-shaped recovery has done very well, that will come back when the COVID receipts, these companies will rarely shutter down like anything, and that will lead to your next correction in the market.
GE: As you look ahead, what's the one thing you would advise investors? The markets have gone up more than 1,200 points in barely two days. What should you be now careful of and what should you be seeing as an opportunity?
GC: You need to wait till the complete certainty comes from the US election. We can't take it for granted. Because now market believes or whatever comes it is positive, that may not be the reality post selection of the President. According to me, it still remains a big risk. And secondly, the biggest risk is in 2021. Because if the economy is correcting 10% this year, and next year, it is going to recover only 5% to 8%, the absolute output in 2021 calendar year will be less than what we saw in 2019. That is the biggest risk.
So be prepared for 10% to 15% fall in the market and go for least-leveraged cash-rich companies, particularly the leaders, because only 5% of the stocks are outperforming. So, if you go for 100% value stock, then you may be regretting for long. So, go for leaders, but at the same time, the P multiple is not, you know, hugely war-valued as compared to its own P in the last two, three years. So, this is the approach I would suggest but be cautiously optimistic and be mentally prepared for 10% - 15% correction in 2021.
AB: Markets are very frothy. And you know, the bulls only want to see the good news. On the economy front, there is no good news. On the fiscal front, there is no good news. The service economy is hurting. Agriculture is very small. In consumption, it is okay. But in terms of a contribution into GDP, it's small, even if it grows, it's not enough to offset the service fall. So, markets are ahead of themselves. It's not good news.
I see the next decade being value decade. It will move from growth, whether it moves in 2021 or 2022. But there will be a sharp fall, then there will be a back-to-value kind of thing because of the overstretched valuations in the top part of the K-shaped recovery. You know the beneficiaries of the COVID economy are just too So, highly valued. It won't last. It never does.