As folks who follow us on LinkedIn would know by now, this week is going to be a thematic week, focussed on the apparent disconnect between the markets and the economy. We'll begin with a few catalysts that can trigger a potential correction, and then discuss four dominant views that explain why the difference between the two could be here to stay.
So without further ado, let's dive right into the catalysts for a potential correction.
A) Running out of fire-power: The RBI and the government were both extremely proactive in reacting to the crisis and providing the market the support it needed. This trend was not unique to India, but a common theme in most of the developed world as well. While the Fed kept its printers on, the government sent folks 1200$ cheques to spur the economy. Back home, the RBI has been steadily dropping rates, while the government has continued to provide monetary and in kind support to keep people afloat. Knowing someone "has their back" has kept the markets in good spirits as well, but both the central banks and the government could be running out of rope. We discussed the problems the RBI was facing in this detailed post, as it tackles India's rising inflation problem. The government also faces stress with its deficit number rising amidst muted direct and indirect tax collections and unprecedented outflows. Either party taking a step back could be a potential dampner for the market.
B) The big bank blow up: This is one of those things that almost everyone knows is going to happen, but we just don't know the scale of the problem yet. Banks were already under considerable stress before the pandemic began - a situation only worsened by the COVID pandemic. We had covered the impact of increased NPA stresss in our post on Japanification - understanding what the NPA spike could mean for our economy. With Chinese banks showing cracks in their recent results, once the post moratorium data begins to arrive India could present a bleak scene as well.
C) The second wave: While the recovery the market is pricing in is open for discussion, it would be fair to say that most analysts are pricing in a stable FY22, marking a sharp recovery after a deflated FY21. This ofcourse will only happen if we reach close to normal business (via herd immunity or a vaccine), and assuming the bank stress doesn't put us back a few years. And then ofcourse there is the looming threat of a second wave. A more virulent modified strain that could not only infect new people but also reinfect folks who might have recovered. While this is not a scenerio we would want to think about right now, it is important to recognize it as a likely potential risk.
D) Geopolitical tensions: Even amidst the pandemic, the expansionist neighbours to our north keep going. After a border issue with Nepal and a conflict with the Chinese on our northern borders leading to the death of 20 of our men, the geopolitical tension angle remains strong. The conflict has now shifted from land to sea, with China firing ballistic missiles in the South China sea to keep US warships away, and India deploying warships in the area.
This list ofcourse can never be completely comprehensive, but we've tried to cover the most important ones here. Stay tuned to see our four other posts on the theme, covering the potential rationale for the mismatch.