Decoupling between Equities
& Economy
Equity market continue to rise while economic recovery remains grim. How far will this go? We
throw light on some pertinent questions in a detailed discussion with two market dignitaries – Mr
Harshad Patwardhan - CIO Equities, Edelweiss AMC & Mr Aditya Narain – Head of Research,
Institutional Equities, Edelweiss Securities Ltd.
In this interaction we try to bring out perspectives of market connoisseurs in tackling the COVID
contingency and how to weather the storm in your investment portfolio. Lastly, what’s the
roadmap for equities as an asset class & what should be the approach of investors looking to invest
in equities.
What do you make up from the recent bounce back in the equity market? Equity indices are up
more than 40% from their lows? What is aiding this sharp bounce back rally? During crisis FII
flows have always created a havoc in India and recovery is also led by them. How are FII flows
into Indian equities in recent months and how are they impacting?
Harshad: One should not forget that this recent rally is after a sharp market fall of about 40% and
then From the March lows, markets are up by 45%. That fall was led by the panic created due to
Coronavirus
From the below chart which shows the FII Flows & Domestic Flows (Institutional Flows)
4,000 2,473
1,373 1,787 1,719
2,000
1,373
- 414
-31 -218
(USD mn)
-2,000
-2,441 -2,659
-4,000
-6,000 -4,915
-8,000 -6,603 -6,634
-10,000 -8,390
Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20*
FII-Monthly FII-YTD
14,000
11,530 11,851
12,000
10,137 11,348
10,000
10,030
8,000
(USD mn)
6,000 7,474
4,000 2,664
2,000 1,500
313 2,351 320
- 313
-2,000 -107 -503
Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20*
DII-Monthly DII-YTD
Source: Bloomberg, NSDL. *till July 20, 2020
Decoupling between Equities
& Economy
• The month of March depicts one of the worst FII outflows which was one of the reasons
of market lows
• This is one of the major reasons why the market fell though domestic flows were good
• The Blue Bar depicts the month-wise flows by Foreign/Domestic investors and the red
line is the cumulative flow for the year
• Immediately after the crisis, there was reaction which came from policy makers
• Fiscal stimulus provided globally gave some momentary relief to stop the downfall
because of crisis
• Hence markets bounced back & for Indian markets arrival of FII investments in May &
June in addition to domestic in-flows
• Hence the recovery started mainly because of FII selling stoppage & assurance from
policy makers
Non-Institutional participation in cash volumes
Monthly Avg. Cash Volume (INR b) Non Institution % to Cash Volume (RHS)
750
74 80
70
600
60
450
50
607
300
40
317
301
366
363
224
287
304
309
272
301
326
343
390
347
426
380
354
340
352
312
331
368
417
387
335
325
316
345
410
385
344
349
403
403
446
346
374
426
518
528
561
664
150 30
Apr-19
Mar-17
Nov-17
Dec-17
Nov-18
Dec-18
Aug-19
Nov-19
Dec-19
Apr-17
May-17
Apr-18
May-18
May-19
Apr-20
May-20
Jun-17
Oct-17
Oct-18
Jun-19
Oct-19
Jan-17
Jul-17
Jun-18
Aug-17
Jan-18
Mar-18
Aug-18
Jan-19
Mar-19
Jan-20
Mar-20
Jun-20
Feb-17
Sep-17
Feb-18
Jul-18
Sep-18
Feb-19
Jul-19
Sep-19
Feb-20
Jul-20
Source: MOSL
• The above chart depicts Robinhood investing - term used in US & now in India
• Daily traded volume average from March has significantly gone up from Rs. 45k to 65K
crores in the month of June
• Participation of Non-institutional investor has also bounced up
• This resulted in much-awaited momentum & rally in the markets further
Decoupling between Equities
& Economy
Most economic indicators are southwards and are expected to stay there owing to rise in
infection spread in India? How do you see this disconnect between the economy and equity
markets?
Aditya: Disconnect isn’t bad. In fact, it’s an opportunity rather than problem. Disconnect between
economy & markets were always there but not as sharp. What’s important is the direction of
disconnect
• Usual trend is markets not doing well & economy doing poorly or vice versa. However,
this time its directionally different
• Economy looks at nearer term move with long cycles, hence going down now will take
time to come back
• Markets in contrast reacts sharply; on the onset of COVID news it fell & now bouncing
on news of gradual economic recovery
• Disconnect is not a major problem and the markets generally look beyond the current
cycle and hence, there is a disconnect
• The truth lies between the balance where markets corrects as gradual recovery of
economy starts
• One should keep tab on the extent of disconnect, the direction of disconnect as it will
& should narrow down as we move forward
How healthy has been the recent bounce back rally? What kind of sectors or stocks
participated in this?
Harshad: What is remarkable about this bounce back rally is on the way up the sectors which were
expected to be hit by the crisis including Health scare & lockdown effect, did very well!
• Examples include hospitality & multiplex which will have medium to long term
impact due to lockdown bounced back very sharply
Decoupling between Equities
& Economy
Big Dispersion in Stock Returns
Source: Bloomberg, As of July 21, 2020
• The data above clearly shows dispersion in stock returns has been sharp
• For broad index like NSE 500, the YTD index down 8% but Top performing stock up
160% & Worst performing stock is down by 67%
• Even on a one-month basis, numbers look the same; hence huge dispersion
Factor Analysis
Source: Bloomberg, Internal Research
Decoupling between Equities
& Economy
• The above chart is the Factor analysis which shows stocks attributing to which
factors did well during the bounce back.
• How we arrive at factor analysis is that we take the top stock in the quartile & the
bottom quartile. The above is for quarter (April, May & June)
• The difference between the two is then used to arrive at beta value which is at 15%
in the above case
• This proves that high beta stocks massively outperformed low beta stocks
• In short low ROE stocks outperformed high ROE stocks; high growth stocks
underperformed low growth stocks and so on
How do you look at the recovery in the economy. How much time will it take for economy to
normalise? How will government and RBI’s efforts aid in this recovery?
Aditya: One needs to understand the basics of recovery which is, what is going to drive the
recovery and what will be its shape. The bottom-line is -5% to-6% recovery for this year and a
bounce back to 6-7% in the next year. Which suggest FY22 will be at the same level as FY 20 This
is for numerical purpose, but one needs to understand what’s going to change in the system and
which businesses, sectors and consumer segments that are going to drive it
• We believe FY 22 at an economic level same as FY 20
• The composition is however going to differ
• The second thing is which business are going to drive stocks, and which are going
to drive economy?
• First demand pent up is expected near Diwali season
• Another 3 to 4 months from now, consumer confidence is expected to come back.
Hence, Diwali is a good time to see how demand has been affected
• The real shape of economy recovery will be seen in FY 22; 12 to 14 months from
now
• Work from home then would’ve ended in FY 22 hopefully
• FY22 GDP nos. can be very different from FY 20, especially in composition
Answering the Second part of the question where RBI efforts are concerned, they
seem to have taken appropriate measure
• Put in liquidity & uplifted banking system
• RBI hasn’t taken huge risks & played it well with adequate liquidity
• Have not gone overboard like US or European response
Decoupling between Equities
& Economy
• Approach is measured & has an option to offer more whether to cut rates or infuse
liquidity. Hence been cautious
• As far as Government is concerned - Cyclical downside could be higher hence they
have been cautious
• Opportunity now with supply side constraints eased off to take aggressive
approach on demand side reforms
• Gov needs to take risks to accelerate the economy; Expect more from Government
in coming months.
Given the current situation how are you weathering the storms in your portfolios that you
manage? What changes have you done to your portfolios?
Harshad: Framework which we’ve used has been borrowed from Nassim Talib in his famous book
– Anti Fragile. Way we classified stocks – 3 buckets
• 1st bucket – Fragile stocks - that break under this shock or pressure
• Hospitality, multiplex, retail, etc. These are industries that will not only experience
small to medium shock; but also change in dynamics
• What we’ve done in our portfolio is getting rid of them even if at a loss
• 2nd bucket – Robust Businesses; Medium term prospect not affected
• FMCG & pharma business which will not have near death experience, though few
minor shocks
• 3rd bucket – Anti fragile businesses which will benefit from this chaos
• Telecom business – Benefitted from the contingency
• We’re well positioned in those type of businesses
• This is the framework we’ve used and accordingly have positioned our portfolios.
How India stands compared to its emerging market peers in terms of strength of its economy to
deal with this crisis. Be it on currency, Fiscal deficit or CAD front? How much room do RBI and
Govt have to provide stimulus to the economy?
Aditya: Rally has been sharp and there’s argument for it; it has followed the emerging market
rally.
• Firstly, China stands ahead – their economy hasn’t taken such a hit including
lockdowns
• Though they’ve issues including relationship with US; however, the COVID impact
is minimal
Decoupling between Equities
& Economy
• India is in middle considering the Fx & Currency reserve perspective, India better
placed
• Trade surplus in recent past for India which impacted current account deficit
positively
• The last 2 crisis in 2008 n 2013, the Indian currency dropped drastically; however,
not much this time and is in better shape as other emerging markets
• However, on the Fiscal deficit parameter, India is on the backfoot
• Central Gov has high fiscal deficit & combined fiscal deficit is even higher. This is
one of the major reasons why the Gov has adopted Defensive approach
• Important to note how India as a market has reacted
• In the dip that happened – First dip, India was the poorest performing market of
the lot. Rally was also lagging, however, recent past it has picked up substantially
• Macro perspective, India is on the middle of the road
• In Market perspective it has been a laggard, but made up on lost ground in recent
months
• Time for India to switch from support to growth driven economy.
• There is no fundamental rule how much Fiscal deficit is good/bad
• Fiscal going to deteriorate globally
• Being a Deflationary type of event, Fiscal deficit largely related to risks on inflation.
Hence if risk on inflation is low then come back will be easier
Midcaps and smallcaps have had one of the toughest times over last 2 years. When will they
bounce back and what could be the triggers for the bounce back? Is it a good time to invest in
them now?
Harshad: Both 2018 as well as 2019 have been tough years for mid and small caps. Nov & Dec last
year, we saw first sign of mid & small cap start to outperform large cap by small margin
• Unfortunately, during COVID crisis, where nifty itself fell by 40% but interestingly
Mid & Small caps has not lagged large cap behind by too much margin
• If one looks at 1M, 3M, 6M, YTD performance, there’s not much difference
• Heartening to see that gap is not too much
• In the last 2-3 years mid and small cap performance has been below par. However,
signs of them picking up is a sign that it’s expected to do better
• Since they haven’t underperformed much in this crisis, they are likely to
outperform in medium term perspective
• Avoid Midcap and small cap stocks that are poor quality than large cap
Decoupling between Equities
& Economy
• The way we build mid and small cap is that we buy best companies in smaller
segments. These businesses are with strong management and balance sheets
• From a 3-year perspective, it’s assumed that you’ll make more money in mid and
small caps than large caps
Switching to global economy US markets is rising like anything. How US Fed moves are driving
asset prices? How will these policies impact the equity markets in coming months?
Aditya: The no. of people following Nasdaq and S&P 500 are only increasing with time. Firstly, US
economy was doing very well before COVID struck
• Hence, markets bounced back strongly since the US economy is in full swing.
Disruptions are far less, and the recovery is aggressive
• The policy approach by US has been very clear. The president is growth oriented &
very particular about the growth of the economy
• The FED reserve having 2008 experience have tasted success of its intervention
• Hence, the FED has been very aggressive & supportive in spear heading the
economy
• The third bit is the US elections are coming up. Mr. Biden has been a strong
competitor and has a different approach to recovery and Trump is lagging behind
• US Government and Fed intervened aggressively & limited the damage. This
approach is better for short term, but not in the long term
• The approach of pumping in money also expands your fiscal deficit aggressively
• Inflation & depreciation in currency can be possible in long term
• US in the short to medium term is going to do relatively fine
• The risks lie in politics and longer term
• Though US in leading policy interventionist in 2020 & are stronger than 2010,
considering the risk in intervention and damage in control measures, it will be
interesting to see how successfully they adapt to growth in the long term
How do you look at earnings over the next 1 year. We already have had very patchy earnings in
last few years, will current crisis move that recovery ahead by couple of years? And given that
earnings will be bad how do you see current valuations, are they expensive or reasonable?
Harshad: In the near term, earnings don’t matter much, and in a discounted cash flow valuation
model, near term cash flows like earnings, cash flow, dividends count for only 5-15% of overall
value
Decoupling between Equities
& Economy
• To gauge valuations, we’re trying to look in terms of Price to Book value since earnings
will be very volatile in the near term
• As GDP growth estimates are in the wide band from -2% to -7%, we are looking at
businesses from relative perspective
• Is the chosen company better off than others? Our aim is to not spend too much time
on earning of a company of FY 2021 or 22
• If the business is anti-fragile category, even if the valuation is off-mark, it is still worth
investing
• If the business is fragile category, not worth even if you are buying at low valuations.
Gold has been shining bright amidst this crisis. How do you see the journey ahead for gold?
Aditya: Gold follows a pattern. Whenever there’s uncertainty, flight to safety or money pumped
into system leading to weakening currency, gold goes up
• If there is uncertainty in the economic trajectory and as long as there’s going to be
central bank intervention, gold is going to hold its level
• Near to medium term, gold is comfortable since we don’t know how demand is
going to play out or economies are going to rebalance itself
• Risk to gold is when there’s reversal in economy, when economy attains normalcy,
when interest rates in the US tend to rise
• At this point one is looking at avoiding downside risk to the economy and hence,
Gold is a safe bet and a hedge that will hold at this point of time
Oil has seen a volatile trade in last few months? Your thoughts on Oil?
Aditya: As far as Oil is concerned, there are two-three different dynamics.
• Firstly, the actual consumption; currently the global consumption is at 80-85%
• Second is the Pricing approach where OPEC countries are concerned and their
supply in the market where currently there’s supply cut
• Third is the capacity of holding oil, when that happen prices fall, however, that’s
easing
• Till next year Oil is expected to be at this level at an average of $42 attaining a
maximum of $50
• What important to note is that it was $60-65 before problem started and now at
$50 i.e. 15% drop in the oil prices through the problem
Decoupling between Equities
& Economy
What lies ahead for equity markets? If someone wants to invest now in equities then what
should be the approach?
Harshad: The markets are now up by 40% from the lows of March, but with COVID still in picture
the level of uncertainty is still very high
• Current crisis is best defined as health crisis and hence there is high dependency
on Medical field as to when the vaccination or treatment will be available
• The need of the hour is to be cautious
• How much equity should one add as an asset class? If underweight, then one
should definitely add
• Since there are hoards of Robinhood investors in the market, also resulting in
recent hike
• The Right Approach is a STP approach by slowly adding equities into the portfolio
Disclaimer: Mr. Harshad Patwardhan is the CIO - Equity of Edelweiss Asset Management Limited
(EAML) and the views expressed above are his own.
Mr. Aditya Narain is the Head of Research, Institutional Equities, Edelweiss Securities Ltd and the
views expressed above are his own.
The views expressed above should not be construed as investment advice or recommendation
from Edelweiss Asset Management Limited.
Mutual Fund investments are subject to market risks, read all scheme related
documents carefully.
