The domestic equity markets are in a firm bear grip as they struggle to react to the spread of coronavirus and the resultant global shutdown that is expected to hit economic activity hard. This is in line with what’s playing out in the global equity markets as well.

The current situation is more of a health crisis and not a major financial crisis as of now. What happens going forward is, therefore, going to depend on how the virus situation develops. There is a high degree of uncertainty right now in terms of how the scenario may unfold as this is a true black swan event and there are no reference points available for the markets.

The optimistic case is that if the lockdowns are able to curb the spread of the virus significantly and there are no additional complications, over the next couple of months we could see a meaningful relaxation in the curbs on economic activity, leading to a quick turnaround even though the recovery itself may be gradual, supported by the RBI and the government through monetary and fiscal actions.

The pessimistic case is that we could see a second or third order spread of the virus in the coming months that may lead to a prolonged shutdown in the economy. If that were to happen, the markets can take a further hit because of prolonged uncertainty.

Regardless of the path the virus takes, it is important to note that ultimately this is more of a temporary disruption that the economy will come out of — and so when we take a longer term view — say 3-5 years, we don’t expect any lasting damage to the economy from the current events.

Market action

Indian markets have fallen hard in the last month. What has been devastating is not just the extent but also the pace of the correction — a selloff of 35 per cent in 20 days is pretty much unprecedented. The market correction during the global financial crisis, though it was ultimately steeper, took 6-12 months to play out.

The rapid nature of the fall has a lot to do with the ETF activity. There has been an avalanche of coordinated selling from global funds, especially ETFs, over the last month which has affected all global markets, including India. A lot of the flows into and out of the ETFs tend to be driven by “dumb money” (algos/machines — trying to play the big macro trends across markets without differentiating between stocks). Unfortunately, in recent years, ETFs have become a big part of global flows and we are seeing the devastation that they can cause in the markets when they flow in and out en masse.

One offshoot of the domination of ETFs is that it is entirely possible that the same speed that we have seen on the way down can play out on the way up in case there’s an optimistic scenario and the virus is controlled in a reasonable timeframe.

Valuations below average

The positive side of this fall has been the collapse of the P/E multiple. For the last two years, we have seen markets at elevated levels (>24 times trailing earnings). As on March 23, 2020, Nifty 50 trailing P/E stands at 17.15x. The 20-year long-term average is 20x. While we remain cautious, we believe the reasonably low valuations could be used as an opportunity to top up existing investments in a staggered manner.

The rebound: Continue SIPs

When markets see drastic cuts, they reward/compensate investors who stick to their investment plans and stay invested. A lookback into the last five bear markets shows an interesting fact — equity investors who stay invested during tough times and those who have actively taken the opportunity to add to their investments have been rewarded as the markets normalise.

As the market falls, periodic SIPs help you in two ways. First, they help you to keep emotions out of the way while buying during in the downcycle. Second, they help in rupee cost averaging. This way as the market rebounds your existing investments recuperate while the fresh investments capture the upside.

Policy measures

The government and central banks around to world are expected to take action to help people and businesses manage the economic hit of the lockdowns.

Already several countries have announced steps in this direction led by the US. Major central banks (again led by the US Federal Reserve) have also announced significant easing/ liquidity measures. The same is likely to happen in India as well where we expect the RBI and central and state governments to take measures to provide liquidity to businesses as well as to informal workers in an attempt to cushion the blow in these tough times.

While additional liquidity may not help growth as the shutdown destroys demand, it will help businesses to survive and help recovery once the situation normalises. We will see agile businesses reacting to these testing times with innovation and changes to business models.

It’s difficult to catch falling knives and at times like these, investors often tend to question their investment decisions. However, we should never let a good crisis go waste. The silver lining in this crisis is the sharp fall in market valuations that is allowing investors to enter the markets at levels that have historically resulted in sustained long-term rebounds. While at this juncture one does not know how long this crisis may go on, one may believe that the Indian economy and markets are resilient enough to rebound from this hit.

Investors are advised to invest systematically and stagger investments over the next 3-6 months even as the recovery will not be as swift. Equities should be a preferred asset class for investors looking to build and maintain portfolios with a 3-5-year horizon.

The writer is head of equity, Axis AMC