Global financial markets that were cheerfully sailing on fair winds of liquidity, infused by global central banks, have been suddenly hit by a giant wave of selling that has sent prices crashing and left investors gasping for breath.

Even until mid-February, investors were complacent that the coronavirus would be contained within China and a few other countries. It’s only when it became obvious that the virus was set to wreak havoc through Europe and the US that panic gripped investors.

The S&P 500 lost 33 per cent in just 20 sessions, one of the swiftest declines in recent times. The CBOE VIX, the investor fear gauge, hit 85.4, a level last recorded in 2008, and the CRB index that tracks commodity prices, is at its lowest in two decades.

What makes this market fall different from the 2008, 2001 or 1992 crashes is that the cause for the ongoing decline is a virus that threatens the entire society.

The Covid-19 pandemic that began in the Wuhan province of China in December 2019, has already affected 206 countries, infected over 9,76,000 people and claimed around 50,500 lives. And the pandemic’s peak is at least two weeks away.

If we look at past pandemics of similar intensity and scale, the 2009 H1N1 flu and the 1918 Spanish flu are the closest comparisons.

The 2009 pandemic infected between 700 million and 1.4 billion people across the globe, accounting for 11-20 per cent of the population, and killed 1,51,700-5,75,400 people. The virus was most virulent between April 2009 and April 2010.

The Spanish flu (1918-1919), the deadliest pandemic in recent history, infected about 500 million people, or one-third of the world’s population then, and claimed 50 million lives.

It is, therefore, quite likely that the ongoing pandemic continues over a large part of 2020.

It is, however, difficult to gauge the economic impact of the earlier pandemics since both began when global economy was in doldrums. The world was just emerging from the Global Financial Crisis in 2009 and the First World War was drawing to an end when the Spanish flu began.

This time around, the Covid-19 crisis has erupted when the global economy, especially the US economy, was on a reasonable sound footing and stock prices were at record highs.

Central banks and governments are currently pulling out all the stops to keep together their house of cards.

What’s the way ahead for the economy? What does it mean for investors?

Recession is here

The ‘R’ word that developed economies have been trying hard to stave off over the past few years is finally here.

Georgieva Kristalina, Managing Director of the International Monetary Fund (IMF), has warned that the outlook for global growth is negative in 2020 and we are looking at a recession at least as bad as the global financial crisis, or worse. She is, however, optimistic about a recovery in 2021, depending on the policy response of countries.

World Trade Organization (WTO) Director-General Roberto Azevêdo has echoed Kristalina’s views, adding that a sharp decline in global trade is also likely.

Many economists have revised their forecasts for 2020 lower, while others are still waiting for high-speed data on February and March. The UN Department of Economic and Social Affairs (UN DESA) has warned that global growth can shrink by up to 0.9 per cent in 2020.

Economic research by S&P Global expects global growth at 0.4 per cent in 2020, dragged down by contraction in major regions such as the US (-1.3 per cent), Eurozone (-2 per cent) and Japan (-1.2 per cent). It, however, expects India (3.5 per cent GDP growth) and China (2.9 per cent) to stay afloat in 2020.

But all economists concur that there will be a sharp contraction of 10-20 per cent for all major economies in the June 2020 quarter.

According to the United Nations Conference on Trade and Development (UNCTAD), developing markets have taken a larger hit over the past two months due to capital outflows, growing bond spreads, currency depreciations and lost export earnings, including from falling commodity prices and declining tourist revenues.

The UNCTAD also thinks that the kind of rebound witnessed in developing countries between 2009 and 2010 is not possible this time. It points out that portfolio outflows from main emerging economies was $59 billion between late February and March 2020, which is more than double the outflows experienced by the same countries in the immediate aftermath of the global financial crisis — $26.7 billion. It also expects foreign direct investment flows to drop 30-40 per cent in 2020, and stay sluggish in 2021.

Central banks and governments of larger economies have unleashed a slew of monetary and fiscal measures to support their economies. The US Federal Reserve’s large rate cut and $2-trillion stimulus package, and the European Central Bank’s promise of unlimited liquidity have been aimed at reducing the economic distress in the coming quarters.

But as the IMF pointed out, the relief packages are being mainly unveiled by G20 nations. Many low-income economies are going to find it more difficult to take similar actions as they are already hurt by investment outflows. The debt distress in developing economies is also of concern. The IMF estimates that $2.5 trillion is required to help developing and low-income countries.

This implies that even if the virus is contained by the September quarter and the G20 nations slowly get back on their feet, global consumption and trade can remain crippled for a longer period due to the slower recovery in other nations.

Indian economy on slippery slope

The growth numbers for the Indian economy were quite bleak even before the outbreak of Covid-19. The Central Statistics Office (CSO) had estimated a nominal growth rate of 7.5 per cent for FY20, the lowest in the last 17 years.

Manufacturing activity has been in a structural decline for many years and growth in private consumption had collapsed in the aftermath of the IL&FS crisis.

Lack of government capital spending in FY20 had made gross fixed capital formation crumble as well in FY20.

The 21-day lockdown, along with the extended impact on travel, hospitality and non-discretionary consumer spends, is expected to deal a major blow to growth in FY21.

According to SBI’s Ecowrap, there is likely to be a 1.7 per cent impact on real GDP in FY21 due to the lockdown, which has brought at least 70 per cent of the economy to a standstill.

The total cost of the lockdown is estimated at least at ₹8.03-lakh crore in nominal terms; translating roughly to 4 per cent of GDP.

Many measures have been taken to reduce economic and social distress. The RBI has cut its policy rate by 75 basis points, and provided additional liquidity through TLTRO (targeted long-term refinancing operation), increasing marginal standing facility and cutting cash reserve ratio. The three-month moratorium on all term loans and working capital is expected to ease the burden on retail borrowers and smaller businesses. The Central and State governments’ provision of rice, pulses and cash hand-outs may also provide marginal relief to the needy.

But the trouble is that the Centre will be facing a double whammy in FY21 — falling tax and divestment revenue, and the need for higher expenditure to tackle the crisis. While the fall in crude prices provides some relief, it will be nullified by foreign portfolio and FDI outflows. These will pressure the rupee, resulting in depletion of forex reserves.

It is, therefore, not surprising that most economic research outfits have revised India’s GDP growth for FY21 sharply lower. SBI economic research pegs FY21 GDP estimate at 2.6 per cent, with a clear downward bias.

It expects contraction in the GDP of June 2020 quarter, and has revised the FY20 GDP lower from 5 per cent to 4.5 per cent.

UBS expects India’s growth to slow to 2.5 per cent in FY21. The growth is expected to be 4 per cent in the optimistic scenario — if the disruption is contained in mid-May — but the lower range for growth is -0.2 per cent, which can happen if the interruption extends to September.

CRISIL has slashed the base-case GDP growth forecast for FY21 to 3.5 per cent from the 5.2 per cent expected earlier. This assumes a normal monsoon and the effect of the pandemic subsiding materially in the June quarter. Many other economists have projected growth for FY21 between 2 per cent and 4 per cent.

It needs to be remembered that we are still in the lockdown period and there is uncertainty over how long the movement restrictions will continue. These forecasts are likely to be revised over the coming weeks and months as the pandemic peaks and finally tapers down. What is clear at this point is that the June 2020 quarter will see economic output shrink very sharply. If the virus is not contained in the June quarter, we could be staring at GDP contraction in FY21.

Outlook for markets

So, what does all this mean for you as an equity investor? It means that expectations about stock returns for FY21 need to be scaled back significantly.

The Sensex and the Nifty 50 lost over 35 per cent from their February peaks when the indices hit their recent lows. This sharp decline has helped bring down valuation of large-cap companies to extremely interesting levels.

The trailing 12-month PE multiple of the Sensex has declined from 27.9 towards the end of December 2019 to 17.18 now. The price-to-book value ratio has declined from 3.21 to 2.19.

For the Nifty 50, the price earning multiple corrected from 28.3 to 18.6 and the PB ratio fell from 3.75 to 2.35.

Valuations of many large-cap companies have also moved down to very attractive levels, well below their three-year average price-earning multiples.

There are, however, two factors that weigh on near-term appreciation in stock prices.

One, revenue and earnings growth in the June quarter is going to contract for most businesses and the overall growth for companies is also likely to be much lower for FY21. According to UNCTAD, profit guidance from multinationals in developing countries have been revised downwards by 20 per cent since the start of the pandemic. Many research reports also point to a downward revision of around 20 per cent in FY21 earnings. India Inc, which was already struggling with poor earnings growth in recent quarters, is likely to be further hit by the slowdown due to Covid-19.

Two, the decline in stock prices has been led by foreign portfolio investors, who are pulling money out of all emerging markets due to growing risk-aversion. These outflows will not abate until the virus is contained.

But as explained above, valuations are becoming very attractive now. Instead of focussing on the challenges over the next couple of quarters, investors need to buy low-leveraged companies, backed by sound business models, with a three- to five-year perspective.

Sectors hurt by the virus attack

Some stocks and sectors have been badly affected by social distancing and movement restrictions.

If you have a medium-term view (one month to a year), you may want to play it safe in these themes. However, if you have a long-term horizon, it makes sense to play contrarian and pick the fundamentally sound companies in these segments. For bad times don’t last forever, either.

Impacted by social distancing

Airline companies have been battered by investors as flights have been grounded and international borders sealed. While Indigo is down around 30 per cent, Spicejet is down a steeper 58 per cent. The relief from low crude oil prices is going to be offset by the loss in revenue for these companies.

Leisure travel is likely to reduce considerably for the rest of the year, affecting the hospitality industry. It is not surprising that most hotel stocks are down 40-65 per cent since February 20.

Investors, however, seem to be betting that food takeaways will continue, with Jubilant FoodWorks down a lower 26 per cent.

Tour operators, restaurants and multiplexes are other segments that are likely to suffer through 2020.

Discretionary consumption

As the focus shifts to survival and making do with basics, discretionary spending is going to take a back seat. UBS expects private final consumption growth, which was at a multi-year low of 4.3 per cent in FY20, to fall to 1.4 per cent in FY21.

According to SBI Ecowrap, income loss due to the lockdown will be to the tune of ₹1.77-lakh crore and loss in capital income of ₹1.69-lakh crore. Job losses are also expected in agriculture, trade, transport and hotels. Also, the sharp decline in stock prices has eroded investor wealth equalling ₹44,25,000 crore.

These are likely to impact discretionary consumption across the board — from automobiles to gems and jewellery and textiles to consumer durables — for FY21.

Commodity producers

As explained earlier, global growth is going to slow considerably in 2020. This will hurt demand for crude oil, metals, chemicals, etc. Commodity prices have, on the whole, declined 37 per cent this year, according to UNCTAD.

While this is good for user industries, the commodity producers in the listed universe, including oil-and-gas and metal producers are going to be hurt by the decline in international prices.

Global trade is also going to take a hit, with global manufacturing exports declining $50 billion in February alone.

Banking

Banking and financial institutions have borne the brunt of selling over the past month, with losses averaging at 43 per cent.

In addition to earlier problems including slowing credit growth and asset quality concerns, the ongoing lockdown and the moratorium announced by the RBI have created a fresh set of problems.

Asset quality is likely to deteriorate in FY21 due to the problems faced by retail, corporate and small businesses. Job losses, pay-cuts and a sharp decline in revenue due to lower customer spends are likely to impair the ability of the borrowers to repay loans, even after the lockdown period.

Sectors that are still afloat

Consumer non-discretionary goods manufacturers have been treated more kindly by investors, with companies such as Hindustan Unilever, P&G Hygiene, Dabur and Colgate-Plamolive escaping with milder cuts of less than 15 per cent.

Similarly, many pharma companies such as Cadila, Ajanta Pharma, Ipca Lab and Dr Reddy’s Lab have been spared heavy badgering in the ongoing decline.

IT stocks are also expected to be less hurt due to their ability to function from remote locations. However, reduced order flows due to clients constricting their spends could hurt their bottom-lines this fiscal year.

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