Black swan event for Indian stock market

Black swan event is a highly improbable event which catches everyone by surprise. The name stems from the fact that up to 1697 it was believed that swans are white only. But it completely turned incorrect when Dutch explorers sighted black swans for the first time in Western Australia.

COVID-19 pandemic is such an event for global stock markets as no one had ever expected that such a pandemic will happen with such devastating impact on the economies world over.

Apart from the tragic human consequences, the COVID-19 pandemic has sparked off economic uncertainty which is estimated to cost the global economy $1 trillion in 2020 as per the UNCTAD. S&P has estimated global GDP falling by 2.4% this financial year. Parallels are drawn with the financial crisis of 2008 and the great depression of 1930. Indian economy which was already sluggish before the Coronavirus outbreak is now sure to suffer recession. Indian economy expanded by 3.1 per cent in the last quarter of financial year 2019-20 and for the full financial year, GDP recorded a growth of 4.2 per cent, weakest since the ‘Financial Crisis’ hit more than a decade ago. Only the first seven days of the lockdown 1.0 had coincided with the 4th quarter of financial year 2019-20 which offers a glimpse into what is expected in the subsequent quarters of the current financial year.

Stock markets which are considered as barometers of economic prosperity were bound to reflect the extreme impact of this pandemic on the economies. Stock market indices of all the major economies like US, UK, France Germany, Italy, Spain, Singapore, Hong Kong have declined sharply between 25% to 32 %. In India, Nifty which was 12,084 on 6th February, 2020 had declined to 7610 on 23rd March, thereby declining 37.02 percent from its peak of 2020. Similarly, BSE Sensex which was 41,142 on 6th February, 2020 had declined to 25,981 on 23rd March, 2020, witnessing a decline of 36.85 per cent. However, the two indices have regained more than 19 per cent from the lows of 23rd March.

The question for the stock market investors is: “Has the stock market in India bottomed out or is this recovery of 19% from March lows”? The fact is that this sharp recovery was largely due to a steep fall in the US Dollar index which had fallen from 103 to 96.5 levels thereby resulting into money pouring out of safe heavens of US government bonds into emerging market equities. If the US Dollar index breaks current levels, we could see further upside in emerging market equities, however, the US Dollar index is expected to stabilise at the current levels. To sustain the current recovery or otherwise, much would depend on how quickly the Coronavirus pandemic is controlled,  and whether there will be a ‘V’ Shaped or ‘U’ Shaped economic recovery?

The key risk to the current rally in Indian equities is the uncertainty about the problem of Coronavirus. Instead of being able to flatten the curve, the number of infections are witnessing a sharp increase every day. Experts are of the opinion that most likely the curve will flatten in September, therefore, the economic activities will continue to suffer for some more time. The increasing trend in the spread of virus has done a great damage to aggregate demand due to its psychological impact on consumer behaviour which in turn has impacted the corporate earnings significantly. The emergence of second wave of COVID-19 infection world over is also, talked about by everybody, posing a threat of disruption in economic activities once again. The stark reality is that the Indian economy is not yet out of woods.

The ‘V Shaped’ recovery is being talked about, but all indications point towards ‘U Shaped’ recovery i.e., initially there will be sharp decline followed by slow and gradual recovery and finally once the threat of Coronavirus disappears fully, and global supply chains stabilize, there will be a sharp recovery. However, with a caveat that proper and elaborate fiscal and monetary measures have been initiated to help businesses. The centre has announced a large stimulus package of Rs. 20 lakh crore for the revival of the economy. While doing a post mortem of this stimulus package, it becomes clear that it puts very little money in the hands of common man. The budgetary impact of the stimulus is a mere Rs. 2 lakh crore and rest is directed towards making it easier for MSMEs and others to borrow from banks. Although the banks are flush with liquidity but to believe that PSBs will lend liberally would be a tall order, given the extreme care taken by the banks while lending, due to fear psychosis of “Courts, CVC, CAG and CBI”. Given these constraints, the economic revival will not happen quickly. The possibility of recovery in the 2nd quarter of the current fiscal is least. Most of the economists believe that the economy will start recovering in the last quarter. S&P and Fitch has predicted a contraction of 5 per cent in the Indian economy this financial year.

Given the difficult and bleak economic scenario internally and globally, both macro and micro economic indicators are going to remain under stress. Owing to this hard economic reality, the activity in the stock market is going to remain subdued with a bearish trend. It would be difficult for the market to hold current levels. Falling again to the March low levels or even lower is a likely scenario.

Therefore, it is not time for bottom fishing for the retail investors. Whether it is correction or growth, both phases make equity market interesting and worth taking exposure. But it is highly advisable for the investors not to jump into the market; don’t catch the falling knife. Prudence lies not to try to do ‘Bottom Fishing’ because nobody knows where the bottom lies. It is highly appropriate for the retail investors to venture into the market only once it is explicitly clear that the dust has fully settled.

In the past it has been found that the equity markets tend to move in a non- linear fashion during correction periods with false signals resulting into ‘Bull Trap’. Bull trap is a market situation giving false signal suggesting that a recovery is under way while as the actual trend is still down. Many bull traps were witnessed during 2008 crisis, making investors to get trapped. Therefore, the current recovery should be viewed at with caution.

Final Word

It is wrong to believe that one can earn millions overnight in the stock market. Investment in a stock market does promise abnormal returns but at the same time it exposes wealth to a significant risk. To earn abnormal rate of return, an investor would need to demonstrate stock selectivity and market timing skills which even fund managers fail to achieve many a time. These two crucial skills among other things requires a specialised knowledge and strong risk appetite. Retail investors generally lack stock selectivity and market timing skills and also suffer from dispossession effect. It is owing to these facts that retail investors generally fail while investing directly in the stock market. It is advisable for retail investors to invest through mutual funds and adhere to the principles of Efficient Portfolio Theory which stipulates to invest only a small portion of total wealth in risky assets. Equally important for retail investors is to follow value based investing strategy and avoid, under all circumstances, day trading and leveraged positions in futures and options market.

Dr. Khursheed Ahmad Butt is Professor in the Dept. of Commerce, University of Kashmir.