Marco Trend - The Return of Retail

As the market rallies on the short term distance between economic facts and the excitement of the markets is getting bigger. With that comes analysis of the current situation. However few are willing to talk about the one year and beyond. There is a belief among many that we are never going back to pre covid level business activity. While that is true without any stimulus. Financial intervention both monetary and fiscal can at least for a while extend the cycle again as we have seen in the US post 2009. India is then in a sweet spot.

The biggest near term risk then is the extension of the timeline for a full recovery especially if a second wave of the pandemic sets in. Right now the first attempts at reopening of the economy has had its usual and expected effect of pushing up the case counts on a daily basis as seen here.

So the achievements in terms of a falling death rate despite the rising case count on account of better testing is being put to test. The recent data below shows the death picking up again. This is going to be an important trend that will determine whether we go back into lock down or not. This can significantly dampen hopes of an imminent recovery and delay the return to normal. And this is still our first attempt to get out of wave 1. A second wave would only be a risk after the first one died a natural death and then a second sprung up. As of now region wise lock downs are back based on where the case jumps happened. Not yet nation wide.

In the meantime the initial recovery data combined with the stimulus around the world has created the liquidity fueled stock market rally that rides on the idea that the end is near. This time round it has come not just on the back of central bank liquidity as in the case of the US but domestic savings if I go by the recent news items being floated by the media. A while back all eyes were on new brokerage account activations since March going up exponentially. Part of the reason was that people were sitting at home getting more active in the stock market. But there is another reality that is now coming home as this trend of retail participation is not abating. The rising retail participation as this TOI report states is also backed by moving of money from fixed income investments to the stock market.

Most will end up reading into this as a bubble or a sign that the market has gone too far. That might not be the real story. The mess the pandemic created pushed us on the edge of deflation as reflected in the collapse of inflation.

This has given the RBI even more room not just to cut rates but to use direct bond purchases via LTROs to lower long term interest rates. In this the central bank buys long dated bonds by selling short dated ones. This is bringing down bond yields on the 10 year bonds to levels not seen since almost 2 decades ago.

The trend in interest rates has been set to go lower from here. The pedal is being pushed hard to get interest rate cut transmission down to the banks, meaning that deposit rates go down, cost of funding drops for banks and corporate paper. Eventually this should trickle down to retail loans. The table below shows how state borrowings are seeing lower rates

Some recent CP auctions also attracted much lower rates. Banks are actively then lowering FD rates as one did below.

In light of these trends when you see retail behavior into financial markets recently you will see that this is the return of direct retail investment into equity. The reason for this trend is the collapse in the risk free rate of return to a point where they cannot meet inflation expectations. This search for yield has been the biggest driver of investor behavior everywhere. In the US from low yield bonds to junk bonds etc. Similarly investors here too are now moving into riskier assets in droves. Is this a good thing. Retail frenzy is often known to be seen at the end of a bubble. But we maybe in the early stages of this development. As a larger and larger group of investors allocate fresh funds to equity they will become the moving force in these markets. New savings will also go into equity over safety and this trend could go on for months or even a few years. It may mark the start of a new bubble phase then and not the end as is being cited by some media articles. the trend may exponentially expand and each new high in participation will be called a top and a bubble. But bubbles can go on for longer than you can remain solvent shorting them and so it maybe first time to ride it to the point where systemic risk through debt and leverage in the sector also kick in. Falling interest rates can also lead to repricing of the perception of risk as see in valuations. Lower rates justify higher valuations simply on the basis of Earnings yields equations. Change the denominator in an equation and the numerator will expand that many times. Add to that the monetary and fiscal stimulus that comes with the hopes of getting a recovery that can get us back to trend GDP growth levels, and you have fuel for the fire.

In  short the return of retails is not an event but a trend that has probably been sparked by the crashing interest rates and inflation and will stay for a while. Logic will make this trend hard to justify and amount to missing opportunities that come with macro trends in the market.