Making Sense of the Stock Market Exuberance


We are finally past the brutal second wave, but with our growth estimates slashed and a threat of more waves looming ahead- What Explains the Stock Market's Exuberance?



CONTEXT


Textbooks teach us that the Stock Market and the Economy are closely correlated and often tend to represent each other. However, a global trend is emerging, wherein, despite the deadly pandemic, stock markets across borders are touching all-time highs. The situation is particularly more acute here in India, wherein we just recently overcame a brutal second wave with our Economy contracting for the first time in decades by 7.3%. Going forward, many think tanks and agencies- both regional and global, have slashed our growth estimates for FY22, and a potential third wave is looming ahead. All this while, our markets are fairly bullish-resilient as ever, closing at all-time highs. This has led to a raging debate in academia and the industry regarding a possible “bubble” about to burst soon- with many scholars accepting that stock markets are ignoring fundamentals, and mass-irrationality and herd mentality have become a norm in the market. The industry has defended itself by claiming vaccine hopes, and thereby, the hope of a bright future post the pandemic subsides.

THE MYTH OF CORRELATION



Stock Markets do not represent the Economy as a whole by any yardstick, more so in India, where Income Inequality persists, and the Informal Sector is far away from the mainstream than it is in the west. Secondly, the very nature of a Stock Market tendency is that they are run on valuations, projections and thus are futuristic. Therefore, what Markets do today is a reflection of what tomorrow might look like for that stock/sector/industry. For example, Sunrise Industries, like IT, are always amongst the trader's favourites because the value projection of the industry, backed by the company’s fundamentals, makes it an attractive investment, particularly from a value investing point of view. Thus, while economic indicators like the unemployment rate or GDP figures are often present-day focussed, investing is a game of investor’s confidence in the future.

SECTORAL MISMATCH



Another key feature of stock markets is that they are only concerned with the efficacy of the organized-formal sector and thus fail to account for the informal sector, which was suffering the twin body blows of Demonetization and GST before the pandemic. Interestingly, as it turned out, the informal sector was the worst sufferer of the pandemic and its aftermath. Most large corporations with deep pockets survived and continued operations either via work from home or by building resilient operational models. However, for more than 70% of the total workforce in the informal buildup, there were severe cash crunches, layoffs, and subpar revenue generation. All this, however, failed to add value to the stock market estimates, owing to the structural disconnect between the two.



THE PRESENT-DAY COMPOSITION



The Stock Markets, globally, are dominated by large wealthy investors and corporations, who don’t bother about the people’s suffering or dismay but are practically on the lookout for profits. Globally, foreign investors don’t want to let go of another rally in the present-day mechanism. Therefore, the liquidity push is nothing but money pulled out of other assets like gold and a weak dollar presently. Besides, the vaccine hopes and India’s long-run growth potential make it a good bet for investors.

Another logical observation in the market’s performance is that the biggest gainers today are sectors expecting a quick recovery, like IT, Pharma, Consumer Goods, whereas stocks in sectors not expected to recover soon, like Travel and Tourism, NBFCs, etc., are seeing a subdued performance.

CONCLUSION



The fact of the matter is, the Economy and its health is the key determiner for investors, however, the relationship between the two is rather complex. The simple rule is that companies or industries can thrive only when the economy is in shape, or else, the markets break down. India, despite being in trouble in the near future, is gently poised for growth in the distant future- a demographic dividend, developing nature, and a booming middle class with highly skilled service sector talent. Therefore, the long-run projections are well-grounded; it's just that in the present-day context, investors have become over-futuristic for quick profits, and that is hindering a course correction in the markets. In other words, the hypothesis is that the Economy will bounce back sooner or later and hence the bull run.

REFERENCES


  1. https://atlantafinancial.com/the-stock-market-and-the-economy-are-not-the-same-a-guide-to-understanding-the-difference/

  2. https://fivethirtyeight.com/features/the-economy-is-a-mess-so-why-isnt-the-stock-market/

  3. https://www.thehindubusinessline.com/opinion/the-gdp-vs-stock-market-conundrum/article33308068.ece

FURTHER READING


https://www.morningstar.com/articles/1034789/short-answer-stock-market-vs-economy




Written By: Sarthak Dave (sarthak14dave@gmail.com)

Edited By: Priyanshi Kapoor