Why is Mr market resilient in the face of second wave?

Mr Market – an allegory used by the investment legend Benjamin Graham to describe the contradictory traits of the stock market - has been true to form since early April, keeping cool in the midst of the extreme heat created by the ongoing health crisis in India.

This contrarian behaviour of the market might seem irrational to many, including seasoned investors. One leading market player went to the extent of saying that “stock markets going up not caring about everything happening around us is quite disgusting.” Responses like these are empathetic, normal and understandable. But the market is a different beast and it is in the nature of this beast to behave apparently strangely without any empathy for the sufferings around. So, discerning investors should look for cold economic/financial logic to comprehend the contrarian behaviour of Mr Market.

The disconnect is not new

In FY21 the Indian economy experienced an unprecedented contraction estimated at 8 percent of the GDP. But in FY21 Nifty went contrarian and delivered 71 percent returns. This disconnect was rational from the market perspective. Even though tens of millions suffered and MSMEs went through severe pain, the organized sector, which the market represents, did well. Q4 FY21 results are not yet fully declared, but trends indicate robust recovery in earnings led by IT, leading financials, metals, pharma, cement and many assorted firms cutting across industries. We are likely to end FY21 with an earnings growth of 12 to 15 percent. Markets have the instinct to comprehend and appreciate this apparent paradox of organized corporates doing well while the economy is in a severe recession. Markets can’t be expected to be empathetic to the crisis. That’s the nature of the beast!

Market knows the end game and is looking beyond the second wave

Markets are forward-looking. When the markets panicked and crashed in March 2020 humanity was gripped by an ‘unknown’, with no end game in sight. The Discovery of vaccines has given us clarity on the end game: vaccines winning the war against the pandemic and the global economy staging a vaccine-powered recovery aided by unprecedented monetary and fiscal stimulus. This recovery, led by the US, China and Europe is already on. This emerging robust economic recovery, coupled with historically low-interest rates, has the power to keep the global market rally going, despite high valuations.

FIIs will be back

FIIs have been consistent sellers since April having taken out Rs 15,635 crore from India from April to May 7. They have been buying in markets like South Korea and Taiwan, which are free from second wave related issues. But once the second wave starts flattening with downward indications, FIIs will come back. There are clear indications – from Maharashtra, Madhya Pradesh and Delhi - of the second wave flattening soon.

Market correction likely to be global

While being empathetic to the sufferings around us and doing whatever we can to ameliorate the it, as investors, let us look at the market dispassionately and remain invested in this global market rally. Corrections are inevitable but corrections in this global bull market are likely to be triggered by global factors like the return of inflation in the developed world and the Fed announcing an earlier –than- expected tapering of their bond-buying program. But that is not imminent.

So, investors may remain invested, particularly in segments with good earnings visibility like IT, metals, pharma and leading financials. As a measure of abundant caution in these difficult times, partial profit booking and moving some money to fixed income also may be considered, particularly since valuations are high.