The markets rise suggests investors are ignoring the 'tail risk' of the pandemic

The Mint

June 21, 2020

Posted by Clifford Alvares

• Most of the small and mid-caps are showing the huge impact of the pandemic on their scrawny figures as the coming two quarters will be washouts
• Investors should be circumspect on some of companies where cashflows are low

For the stock markets, next week will mark the expiry of the June series derivative contracts. The expiry will provide how much of the sentiment will stay on the positive side after reopening the economy. Stocks are building some momentum on the upside as investors have started to look at how much earnings can be recovered.

One can see that the clash at the at the Indo-China border was quickly put behind. The grim economic news coming from the US is also now on the backburner. But then sentiments may be running a bit ahead of the economic reality. The run-up in the small and mid-cap stocks are a case in the point. The the BSE Small Cap index gained about 3.7% compared to the 2.8% gains of the Sensex last week. While the economic re-opening is certainly good news for many companies, most companies seem to be rallying on speculation rather than profit growth.

After all, most of the small and mid-caps are showing the huge impact of the pandemic on their scrawny figures as the coming two quarters will be washouts. Investors should be circumspect on some of companies where cashflows are low. Nevertheless, continuous inflows into the markets can keep the optimism levels going for a long time. Globally, the combined stimulus across the world exceeds $18 trillion, which is about 21% of global GDP. But for some companies like Reliance Industries Ltd, the race has been all about lowering debt. The firm alone added about ₹1.1 trillion in market capitalisation last week, which is about 20% of the total market cap addition among Sensex stocks. The company said that it had become net-debt free after a record fund raising in Jio Platforms. Of course, some of the cash has yet to come in, such as from the rights issue, but that has not deterred the stock from racing higher and making fresh all-time highs during the covid-19 times.

For companies such as LIC Housing Finance, the realty sector is showing signs of weakening; besides, dud loans are rising. The covid-19 pandemic is also likely to play spoilsport with the recovery of some companies such as Pidilite Industries Ltd. And for companies such as Shoppers Stop, the pandemic shows how tough it is to be a retailer. Nevertheless, there are some companies that have managed much better results. Muthoot Finance’s gold loan business seems to have perked up even in covid-riddled times.

Activity in the spot electricity market is also improving on the back of falling electricity prices. That is seeing Indian Energy Exchange business gaining traction in recent times. For pharmaceutical companies, demand for drugs has been bolstering business growth. IPCA’s domestic market business has improved in the last quarter, and there are signs that it could do better in the coming quarter.  But the economy has still a long way to go to recover. The WPI, which is a good measure of pricing power, shows that deflation continues to dog the economy, and provides early warning signs to policy-framers. That said, the markets are deep in overvalued territory. A Bank of America Global Fund Manager Survey says that about 78% of global fund managers see markets as the most overvalued since 1998. Besides, the ‘tail risk’ to the markets from the rising number of cases of the deadly covid-19 is not yet behind. Around 49% of fund managers still think that a second tsunami of infection could batter the markets.

Also, Indian equities are hovering near the overvalued zone. On its past earnings, the Nifty 50 is priced at about 21 times earnings. Besides, there’s an unprecedented downward pressure on earnings due to the pandemic. So, investors may find valuations less comforting even as sentiments rule for now.

Reference: https://www.livemint.com/market/mark-to-market/the-markets-rise-suggests-investors-are-ignoring-the-tail-risk-of-the-pandemic-11592739702216.html