Market is negating economic realities; how to play in such a market?

At first glance, it looks like India's economy and the stock market are going in opposite directions.

Moody's Investors Service on June 1 downgraded India's rating to BAA3 and maintained the negative outlook.

On June 2, equity benchmark Sensex jumped over 370 points in morning trade and looked on course to extend its winning streak into the fifth consecutive session.

Divergence continues

On May 29, the government's data showed India's GDP grew 3.1 percent during January-March this year since the disruptions caused by the novel coronavirus pandemic punctured economy.

The GDP growth for FY20 came in at 4.2 percent, against 6.1 percent in FY 2018-19.

The GDP numbers may touch unprecedented lows during the April-June quarter as restrictions and lockdowns continue to constrain people's movement, severely hurting economic activity.

However, the market ignored the weak GDP prints and rallied about 3 percent in the next trading session.

G Chokkalingam, Founder and CIO, Equinomics Research & Advisory pointed out that across the world including India, the divergence between the markets and economy continues to grow. Despite India showing a huge spike in the number of infections, the Sensex recovered 25 percent from its March 2020 low of 25,981 to 32, 424 on May 29.

Sensex, however, is still down about 23 percent from its 2020 high of 41,900.

Chokkalingam believes the market remains vulnerable unless a cure for COVID-19 does not come.

"WHO has warned that a second wave of the virus is more than possible if discipline on social distancing norms is relaxed too soon. US Fed Reserve Chairman has said a potential surge in coronavirus infections could derail the recovery from the deep downturn triggered by the pandemic," he said.

While the lockdown has been eased significantly and the market seems to be cheering it, there is a possibility of reintroducing restrictive measures or one-third to one-fourth of the population staying at home and not participating in the economic activities.

"Certain sectors and segments like cinemas, airlines, consumer durables, etc would continue to be impacted till successful vaccines are found and a majority of people are vaccinated. Therefore, in our view, significant contraction in the Indian economy in FY2021 is inevitable," said Chokkalingam.

The outlook is uncertain

Experts warn that the market cannot ignore deteriorating macroeconomic indicators for a long time and ultimately it has to behave in sync with earnings expectations and trajectory of economic growth of the country.

Rahul Bajoria, Chief India Economist at Barclays said that due to production and supply chain issues in necessary consumer goods, and lack of accessibility for services and manpower, India’s economic vitals will continue to flash red for some more time, and a return to normalcy may only be seen through from the third quarter of the calendar year 2020.

"Data released last week showed that the economy continues to decelerate, with India’s GDP growth slowing to 3.1 percent YoY in the March quarter. We expect growth to weaken further, as the extended lockdown continues to cause heavy economic losses. We expect the long period of lockdown, which began in late March, and has now been extended until end-June to have a tremendous economic impact," said Bajoria.

Ajit Mishra, VP - Research, Religare Broking is of the view that the recent surge indicates that the market is focusing more on the optimistic side and anticipating a favourable scenario.

The technical charts are showing the market is heading towards 10,000.

"We have now reached 9900-9950, which coincides with the ‘89 EMA’ on a daily chart and is considered to be a decent resistance. But the way charts are shaped up, the possibility of surpassing it and heading towards 10,000-10,200 cannot be ruled out," said Sameet Chavan, Chief Analyst-Technical and Derivatives, Angel Broking.

How to play in such a market?

Identify themes, stocks to invest and do not get carried away.

Ajit Mishra of Religare Broking suggests maintaining a positive yet cautious approach as the Nifty is closer to the resistance zone of 9,950-10,050.

Besides, the continuous spike in COVID-19 cases and subdued earnings may cap the upside ahead, he said.

On the global front, further deterioration in US-China relations is another important factor that could unsettle markets across the globe.

"In short, traders should use a further surge to liquidate aggressive longs around the hurdle and wait for any dip to re-enter," Mishra said.

Sameet Chavan of Angel Broking is of the view that individual stocks from midcap space can be a good bet now.

"Now going ahead, we may see individual midcap stocks giving better trading opportunities because the way midcap index is positioned, stocks from the broader market would see some decent relief rally," Chavan said.

"It would be important to identify apt themes and then potential movers who within the respective themes," he added.

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