How markets are currently speculating on two factors?

The graph below summarizes how the markets are swinging between extreme optimism and extreme pessimism, governed primarily by two factors

Every country is trying to flatten the COVID-19 curve and putting in measures to make the economic recovery trajectory steeper post COVID. I would focus on the graph related to economic recovery post-COVID. V-Shaped, U-Shaped or L-Shaped (in the decreasing order of the slope and their desirability), are the trajectory being discussed. Several scholars have developed different scenario-based models on how the trajectory of recovery for the economies could look like after the coronavirus subsidizes.

The pursuit to increase the slope and make the growth trajectory steeper is being governed by two factors, both speculative. Time for vaccine development and the fiscal stimulus by the government. The time for vaccine development is a completely independent variable here and no one can predict when it would be available. The most optimistic timeline is early 2021. The Fiscal Stimulus is the territory where governments and central banks can tread to reduce the economic pain. This time around, unlike the Global Financial Crisis, the response has been highly proactive by the governments and central banks across the globe. These measures have contained the bloodbath on global stock markets too.

What keeping the markets afloat?

Currently, the fiscal stimulus or rather hopes of it are keeping markets afloat but there are limits to it, given the fiscal constraints of India. The government announced a fat stimulus package amounting to 20 lakh crores or 10% of GDP; the biggest ever in the Indian history in absolute or percentage terms. As expected, markets rallied. Until positive announcements around vaccine development and fiscal stimulus keep coming in, the markets will stay away from the panic button.

The stock markets in India and across the globe have staged an unprecedented recovery from the lows of late-march. The recovery has been largely driven by government announcements and positive news around vaccine development. But the uncertainty in markets is unlikely to end anytime soon, and bigger challenges lie ahead, especially for India. Given the fact that the lockdown was effective only in the last week of March, the effect of lockdown on Q4 FY2020 should have been minimal but different indicators for Q4 FY2020 paint an abysmal picture for the period even before that; the earnings release of FMCG giant Hindustan Unilever and conglomerate Reliance Industries confirmed it. The pain in the markets would run deep as financial impact gets realized on the statements and a clearer picture is drawn.

More value ahead?

At current levels, stocks in a few industries are trading at all-time highs but are the prospects of these companies so bright that they would tread this crisis unscathed. Seems unlikely! It’s just the extreme optimism around a company that’s driving the market. For instance, the day oil prices went negative, the Asian Paints stock neared its all-time high, only to drop more than 20% in the coming weeks. The driving force was the reduction in the prices of the primary raw material of paints, which is crude oil. Did a pragmatic investor ask whether people are going to get their houses painted when their earnings are likely to be subdued for a prolonged period? Oh, that’s something the stock market can factor in some other day.

Does that mean there is room for more value to emerge in the future? I think so, the prices still don’t reflect the real impact on the current pandemic-induced financial crisis. The value investors could wait.

Flatten the curve?

Amidst all the announcements, one has to track the slope of other graph; the graph of COVID-19 cases. The faster the curve flattens, the faster the recovery in the economic activity, the faster the growth of companies and the stock markets. The governments will run out of the room after a certain period for fiscal stimulus and time for the vaccine isn’t the most logical thing to predict. Amidst the game of speculation on fiscal stimulus and time for vaccine discovery, make sure you don’t end up being a pig. As the saying goes; Bulls will make money, bears will make money, but pigs will get slaughtered.