Ballooning Indian stock markets’ rising disconnect with reality

Stocks boom amidst economic gloom


January 25, 2021

/ By / New Delhi

Ballooning Indian stock markets’ rising disconnect with reality

Celebrations at BSE in Mumbai after Sensex surpassed the 50,000 level for the first time (Photo:Twitter)

For a year dominated by the worst global economic downturn in over a century and the first ever recession in India, the stock markets have outperformed themselves, with their incessant rise. The disconnect between the markets and the real economic plight of the country has been rising sharply, leading even Governor of Reserve Bank of India to warn of a bubble.

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Right from the days of the first Big Bull, Harshad Mehta, in early 1990s, there have been several bull-runs in the Indian stock markets. But few can come anywhere near the one that seems to have gripped the Indian stock exchanges ever since April last year. On March 23, 2020, the key index, Bombay Stock Exchange’s Sensex (or sensitive index listing top 30 stocks) had hit a relative low of 25,981 due to the slowing down of Indian economy in the previous fiscal as well as because of reports from all across the world about the severe impact of coronavirus pandemic on the nations as far apart as China and Italy that had already been hit.

Two days later Indian Prime Minister Narendra Modi imposed the harshest lockdown in the world, in a miscalculated and disastrously implemented move. Lasting several weeks, or rather months in various forms, it dealt the worst blow to the Indian economy as practically every single aspect of the economy had come to a grinding halt, with factories, markets, offices, theatres, hotels, transport and educational institutions closed indefinitely.

The results of the lockdown disaster were evident within weeks as data emerged about various indicators, worst being the jobs market as Mumbai-based economic research body Centre for Monitoring of Indian Economy (CMIE), said that as many as 120 million jobs had been lost due to the imposition of lockdown, pushing India’s employment rates to historic lows.

Another important benchmark that hit an historic low was India’s Gross Domestic Product growth rate, which fell by a record 23.9 pc in the quarter ending June 30, 2020, beating all expectations and catching even the government by surprise. From the ‘world’s fastest growing economy’, that the Modi government has consistently been crowing about for the past six years, India had suddenly earned the title of the country being the worst hit by the pandemic.

Economists predict that for Indian GDP to reach same level as it had in 2019 it would take India until 2025

Even though practically all economies were hurt dramatically by the pandemic none had fared anywhere nearly as bad as India, with the closest rival in the blacklist being the United Kingdom, which was battling not just the pandemic, but also a topsy-turvy negotiation with the European Union over the fate of a post-Brexit relationship between the two.

While the economic data bled red, or deepest red in its history, the Indian stock markets began an unprecedented bull run, right from April, even as the entire country and the economy remained comatose due to the lockdown. The Sensex hit a high of 33887 on April 30, a rise of over 30 pc even as the lockdown was extended by Modi and without any insight into what his next move might be. The images of  market hitting new highs practically every day also came in sharp contrast to the images of millions of migrant workers, who had lost their jobs and were left penniless by their employers, walking from cities of their workplace to their villages, often over 1000 km away.

The surreal contrast between the reality on the ground and the stock market dealers has continued pretty much without a break since then. Each month since April, the market seemed to have scaled a new peak even as reports of job losses and factory closures and number of deaths due to the pandemic continued to rise unabated. The markets have shrugged off practically everything that real life could throw at them.

When the economic data about the second quarter of the fiscal, ending on September 30, 2020, was released, it showed that India had another dubious first to its credit. The first ever recession in living memory as the GDP shrank another 7.5 pc, on the back of 23.9 pc in the previous quarter, the stock markets shrugged it off and instead tried to give it a positive spin of it being a ‘smart recovery from the result of the previous quarter’.

The growth has continued since then and all indicators still point towards a very tough and slow recovery that may take years to come about. Most economists predict that for the Indian GDP to reach the same level as it had in 2019 it would take India until 2025 and that too with a lot of good luck and sound economic policies of the government, none of which is currently in sight.

Rising stock markets give a false sense of wellbeing of the economy

Disconnect with data

On January 21 it breached the 50,000 mark, almost doubling in under 10 months. Despite these indicators of a deep-rooted malaise in the economy, the Indian bourses have been roaring ahead all through the year as if the economy was in the pink of health and all was hunky-dory with the country. As a result, Indian stocks are today amongst the priciest in the world, at least in terms of the PE (price to equity) ratios that reflect the price of the stock as a proportion of the earning per share recorded by the company.

The PE ratio is one of the most reliable indicators of the health of the stock markets globally and have guided investors for decades, if not centuries. Not anymore, or at least not anymore when it comes to the Indian bourses. In fact, the disconnect with PE seems to date to the moment Modi moved into 7 Race Course Road in May 2014.

In January 2014, before the elections that brought Modi as the Prime Minister, the PE of NSE50 stocks stood at 18.69. The year ended with PE at 21.16 and subsequently each year, the PE has kept on rising. Even in 2016, despite the disastrous misadventure of demonetisation, the stock markets rose, with the PE standing at 21.93 and the following year, notwithstanding the mismanaged implementation of the Goods & Services Tax (GST) that managed to derail the economy, the stock markets rose again, and the PE shot up to 26.92.

The PE of the Sensex has risen every quarter even amidst the pandemic and now it has breached 34, against a long-term average of about 21.8. All this, while the PEs in peer markets struggle to cross the 18 mark.

RBI belatedly sounds warning bells

After having stayed on the sidelines and watched the markets totally discard reality and move to new highs on an auto-pilot mode, finally, it seems that the Reserve Bank of India at least has come out of its slumber. RBI Governor Shaktikanta Das flagged concern over the disconnect in his foreword to the central bank’s latest Financial Stability Report, which was released earlier this month. “The disconnect between certain segments of financial markets and the real economy has been accentuating in recent times, both globally and in India… Stretched valuations of financial assets pose risks to financial stability,” Das cautioned.

But, instead of taking heed and cooling off, the markets have continued to stay in the stratosphere. The main factor pushing up Indian stock valuations is the flow of cheap foreign funds into emerging markets, especially India. The rise in India’s weightage in the MSCI Emerging Markets Index, on which a vast majority of foreign funds based their country allocations, has only aided this process. Left alone, this flow is expected to continue to rise and push the stocks ever higher.

But it is time for the government to intervene and cool off the markets for two main reasons. First and foremost rising stock markets give a false sense of wellbeing of the economy, which is far from true. Secondly, the small investors, as always, are the ones to enter the super-heated stock markets and that only when it is too late. That is when the institutional investors and big brokers begin to dump the stock and encash their profits at the expense of the small investor.

It has been happening ever since the days of Harshad Mehta and is certain to happen again. But each time the number of ordinary citizens getting burnt in the aftermath has risen and this time the damage would be incalculably more as most of them have already been hit by the economic impact of a mismanaged pandemic. Time to lock the bull back in the pen, before it runs amok in the homes of millions of ordinary Indians.



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