At a time when everyone is focusing on to protect themselves from the coronavirus, with even corporates diverting their few resources to manufacture oxygen, the rally in the markets has taken many by surprise. The Indian stock exchange surpassed the $3 trillion market capitalization, making it the world’s eighth-largest stock market; thus, many individuals have started investing in the stock market.
A report published by the Securities and Exchange Board of India (SEBI) observed that the number of Demat accounts in India increased significantly in 2020.
But what’s unexpected is that while the stock market is prospering, the economy has been going down. For example, India’s GDP dropped by 8% last year. Moreover, 75 million Indians were forced into poverty while the middle class fell by 30 million, but it didn’t impact investors’ bullish behaviour.
The pandemic isn’t the only case where there’s a disarrangement between the stock market and the economy. Even during the Kargil War between India and Pakistan, the Sensex rose by 38%. Investment researchers suggested that war evokes a patriotic spirit in the citizens, encouraging them to invest in domestic companies. But this reason doesn’t apply well to the pandemic.
So why’s the stock market flourishing when the economy is suffering?
Let’s find it out.
Stock Market And The Economy
Between April to July last year, while the economy was falling, the stock market was rising. Economists were baffled by the disconnect between the poor state of the domestic economy and the stocks that are rallying incessantly, and it’s not just India-centric but a global phenomenon. People are not relying too much on the economic readings, such as Strong Foreign Inflows, an Appreciating Rupee, Weakening Dollar Index, and Retail Participation. It’s due to two reasons.
The stock market isn’t about the entire economy: The stock market is about one piece of the economy, i.e., corporate profits.
The nature of the stock market and economy are different: The stock markets are forward-looking, while the economic indicators are backwards-looking.
Whenever someone invests in the stock market, they think about daily news flow, the news around vaccination of 18 and above, shortage of vaccines, rise or fall in everyday cases, etc. Several investors in India believe that once the vaccine is readily available and the lockdown lifts, the corporate profits will recover. However, the economic indicators are backwards-looking as the GDP data tells us what happened in the previous quarter or year. Over the last year, many feel there has been no linkage between the economy and the market movement.
Why Is The Stock Market Rising?
There are five big reasons why the Indian stock markets have been rising during the pandemic.
1. WEALTHY PEOPLE OF THE WORLD CUT THEIR SPENDING DURING THE PANDEMIC:
We can use the data from America to cite an example since there are no such data available in India. Between May and June 2020, the top 25% of the wealthiest Americans cut their spending significantly.
Since they aren’t spending the money on travel, restaurants, shopping malls, they can invest it somewhere.
2. THERE IS A LOWERING OF INTEREST RATES BY BANKS:
The most common response of a central bank during an economic crisis is to lower the interest rates as it makes it easier for the commoners and businesses to get a loan and then spend the money. This way, the economy recovers. But there’s another outcome, too; when interest rates are low, the stock markets become a better option for wealthy people worldwide to put their money than alternative bonds and savings.
The central banks of rich countries have lowered interest rates. Hence, their rich are investing in foreign stock markets, e.g., India. In 2020, the net inflow from foreign investors was Rs. 1.4 trillion, the highest ever since 2002. Alicia Garcia-Herrero, an economist, remarks that by lowering the interest rates, the central banks are pushing the investors towards risky assets, which isn’t new, as the central banks have been doing it since 2018 creating a significant risk for India’s financial system.
3. INCREASE IN DIGITIZATION, WHICH HAS MAINLY HELPED TECHNOLOGICAL COMPANIES:
According to NASSCOM and McKinsey, the world’s digital adoption has jumped by 3-5 years due to the pandemic.
Indians are readily adopting Zoom, social media, streaming services, and digital payments. For example, digital payments increased by 80% in 2020, and more than 1 million provision stores have begun to digitize. This increased digitization attracted foreign investment in companies like Jio. In 2020, Jio managed to raise over Rs. 1 trillion. Hence, the SENSEX IT index outperformed the general SENSEX index last year.
And technology stocks aren’t the only asset class that flourished during the pandemic. The other asset class that grew is cryptocurrency. Since December 2020, the value of 1 Bitcoin has doubled from nearly 130,000 to 260,000. Ordinary people have accepted cryptocurrency.
Moreover, according to a CNBC report, the big institutional investors who used to be sceptical about cryptocurrency have accepted it as an asset class. While talking about cryptocurrencies, a question might arise: Isn’t cryptocurrency banned in India? The answer is no. Investing in cryptocurrency isn’t forbidden, but you can’t buy things using cryptocurrency. So you can invest in cryptocurrency.
4. THE INCREASE IN NEW INVESTORS:
Remember the graph that showed the rise in number of Demat accounts in past year?
During the 2020 lockdown, many students and youngsters, who had enough money and time, started investing in the stock market. A network effect and fear of missing out has been observed among youngsters regarding investing in financial assets.
You might wonder that what motivated the Indian youth to invest in stocks? While in the US, platforms like Robinhood and Reddit encouraged people to invest. Similarly, Indians are getting inspired by YouTube influencers, private chat groups, new trading apps, and one of the best performing web series of 2021, i.e., Scam 1992.
Moreover, ease in investing created by Indian broking apps contributed to increasing figures of investments. Zerodha, a popular app, revealed that in the first quarter of 2020, it only had 250,000 new investors. But by the second quarter, the number rose to 500,000.
How do these apps help? They made it easier to open an account. You don’t need to go out of your home, you don’t need to learn about complicated brokerage charges, and you don’t have to print 500 documents. Hence, people are drawn towards the stock market.
5. A GOOD EARNING SEASON (Q4 RESULTS):
It came as a big positive for the markets; many feel the markets are looking at a bright scenario two months ahead as they always trade over the future outlook. If the absence of a nationwide lockdown and the limited impact of lockdowns announced by the states have reduced anxiety, there is optimism surrounding the vaccination programme. Also, banks, which are considered a proxy for the economy, did not face asset quality crisis as had been expected.
Also, many countries with resources are coming to India’s help – the US removing restrictions on the export of vaccine raw materials, countries aiding India with oxygen concentrators, ventilators, vaccines, and other materials has boosted investors’ sentiment.
Who Is Buying In The Market?
In October 2020, global liquidity and inflow of funds by foreign portfolio investors (FPIs) led to the domestic market rally. The current strength in the market is brought by domestic institutional investors (DIIs) — mutual funds and insurance companies.
In April (until date), DIIs have invested a net of Rs. 9,669 crore against a net outflow of Rs. 11,101 crore by FPIs.
Market data shows that DIIs have overtaken the FPIs in net investment in Indian equities for the first time in seven months. While FPIs have been concerned over the rise in Covid cases worldwide (especially in India) and are exercising caution, market participants say domestic investments have been substantial on various factors. DIIs hope that the impact on the economy will not be as hard as last year.
Impact Of The Rise In The Stock Market
Economists say that while the market positively links to economic growth in long periods of 10-20 years, the same can’t be said for the short term.
The significant risk attached could be a stock market bubble as the stock prices have risen dramatically worldwide. The Reserve Bank of India (RBI) recently cited a bubble building in the stock market as risky assets surged across countries to record high levels during the year. The benchmark Sensex is at an all-time high. It has risen a whopping 100% from the slump witnessed in March 2020 after the Covid-19 lockdown.
The gains, RBI believes, have come on the back of unparalleled levels of monetary and fiscal stimulus, positive news around vaccination, and the end of uncertainty surrounding US election results. The RBI further highlighted that the stock price index is mainly driven by money supply and FPI investments.
Comparing the price-to-earnings (P/E) ratio with its historical trend, the RBI sees overstretched valuations. Price to Earnings Ratio signifies the amount of money an investor is willing to invest in a single share of a company for Re. 1 of its earnings. For instance, if a company has a P/E Ratio of 20, investors are willing to pay Rs. 20 in its stocks for Re. 1 of their current earnings.
The above table shows the P/E ratio of the Nifty-50 Index. An optimal P/E ratio for Nifty is considered 25, and whenever it has reached above 25, the index witnessed a fall. The P/E ratio has overstretched since mid-2020. It technically means you are buying Nifty at a higher price than it should trade.
What Experts Say?
Marketmen agree with the RBI’s ‘bubble’ theory. They see a correction likely at the current levels. In the United States, real interest rates have become negative, signalling the start of a stock market drop. Furthermore, due to the revival of COVID in April-May 2021, our stock market is clearly in a bubble, as seen by our overextended valuation and a drop in demand in a few sectors.
In its Financial Stability Report, the RBI asserted that increased valuation of financial assets could impair the financial stability of any country. But not everyone agrees with the argument of the overvaluation of the Indian stock market; Mark Mathews of Julius Baer, a large wealth management company, said that the “Indian stock market is not overvalued, and the prices fall closer to the actual prices.”
“I think currently, there is a huge gap between the ground reality and market, and I have a feeling that the ground reality will soon catch up. I also feel that foreign portfolio investment outflow, which started in April, will gather pace in the coming days and weeks if the healthcare situation does not come under control,” said the founder and CEO of a leading financial services firm.
What Next?
While FPIs have been selling from the Indian markets, some feel they may increase the pace of the sell-off if the healthcare situation does not come under control soon. If there is a sharp outflow of FPI money, there could be a correction in the markets. So it is a possibility. However, if things start improving in a week or two, markets may gain confidence and renewed strength.
Experts say investors should not look to speculate in the market at this time. While existing investments should continue, fresh investments for the long term can be made. However, stock investments should be in high-quality companies that are better equipped to handle the current crisis and are expected to increase their market share in the current environment.
Those in need of funds and who want to keep higher liquidity with themselves could consider some profit booking since the markets are back at high levels. Those who don’t need the money for the next one or two years can stay with their existing investments.
It’s challenging to predict with 100% accuracy that we’re in a stock market bubble or not; only time will tell. But what’s clear is that there’s no correspondence between the stock market and the economy.
While the stock market has made wealthy people wealthier as they are the shareholders, the working class faces unemployment and poverty due to the pandemic. Hence, it’s clear that the crumbling of the economy has affected the poor the most.
Editing Credits - Sarthak Gupta
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