Kal Mai Girega: The case of a forward looking K-shaped recovery (5/5)

The last six months were a heady roller coaster - global markets melted and then recouped nearly all of the losses. But the recovery has not been uniform. In today’s post, we take a look at the inner workings of this recovery.

U, V, W, , K

In the early weeks of the crisis, experts predicted either a prolonged U-shaped recovery, as economies would need significant time to recover, or a W-shaped one factoring in future virus-case spikes. A sharp turnaround scenario - the V shape - was largely written off. As we look back today, the Vs are staring right back at us. What gives?

A closer look reveals that it is not just investor exuberance, too much optimism, or a new flock of retail investors driving the comeback - but the market making calculations about possible winners and losers well into FY 2022. Firms likely to survive and thrive, which are typically capital-light, low-debt and flexible, have been rewarded while capital-intensive, high-debt firms have been punished in equal measure. So there are actually two recovery paths, much like the two slopes of K, characterizing this recovery:

These two distinct recovery paths hold true globally and extend beyond the stock markets.

Within the global stock market, which is now back to its record highs of Feb, the upward slope of K is populated by tech, health/pharma, entertainment and productivity businesses - companies which have gained from both the short/medium trends emerging from the pandemic and lockdowns, and those that are likely to gain from deflationary pressures and the space left by dislocated (pronounced dying) smaller or less financially-fit competitors. Unsurprisingly, the downward facing slope is home to firms in highly levered sectors such as financial and real estate firms.

Beyond the stock markets, the K shape has emerged in other asset classes like housing. In the US, new house starts and purchases grew 22% YoY in July as mortgage rates touched new lows. At the same time, mortgage delinquency rate surpassed 8.5%, inching closer to the 10% rate seen after the crash of 2008. The simultaneity of these developments highlights (and will likely exacerbate) the underlying inequalities in wealth and income. Similar changes have been observed in their labor market, with the highest job losses being reported from the lowest paid workers, while the highest paid jobs were least affected.

The K shaped progression also applied to countries (and currencies) alike. Emerging markets like Eastern Europe and Russia, Latin America and Caribbean, and Africa are the most severely hit. These are also marked by rapidly rising debt and deep recessions, which will make the cost of servicing debt even more burdensome - so a possibility of financial crises or major debt restructuring cannot be ruled out. Richer emerging market peers such as those in Asia have performed much better.

The path ahead

As uncertainty is subsiding, so are equity risk premiums. But some amount of uncertainty about the course of the pandemic still looms, and will divide the two arms of K farther apart. There is the obvious risk of central banks and governments running out of firepower. And closer home, the possibilities of NPAs ballooning out of control, a larger second wave, and ongoing geopolitical tensions are very real. While the broader markets may emerge unscathed, some parts of the markets and the broad economy still remain highly exposed.

About the Author: The post is written by our EZPP Partner Monika Chaudhary with relevant edits from our editorial team. Monika is a graduate from IIM Calcutta and has worked with Uber.

Disclaimer: All views expressed in the post are personal, and not related to any organization to which the writer belongs.