Stock markets do well when the economy is booming and in good shape, and markets correct when the economy slows or faces a recession, according to popular belief. It may not be always true. This egregious example of modern economics arose in the Indian stock market.
We must first comprehend the idea of discounting to know the disparity between stock values and the uncertain economic future. Investors are looking for clues as to what the markets and the economy may face shortly. As a result, markets are forward-looking in character, i.e., they are leading indicators that try to forecast where the price will go. Markets look at information and start pricing them, keeping the focus on the future.
As a result, when India's state-sanctioned a lockdown in March 2020, equities markets fell by 30% since the market had begun discounting the pandemic's impact. GDP recession, loan defaults, company disruptions, and other reasons all had a role in discounting. Furthermore, stock markets are not entirely efficient, as a perfectly efficient market would include all information in the price. As a result of these circumstances, the correction took place.
If the economy had been left on its own in March 2020, it may have taken years to get back on its feet. Governments all across the world responded spectacularly to the pandemic catastrophe. Governments were anticipated to spend more than normal, resulting in a bigger fiscal deficit, while central banks were expected to lower interest rates and create more money.
As a result, when the Indian government announced Atma Nirbhar Bharat and central banks cut interest rates, markets discounted the good news. Direct cash transfers, unemployment benefits, interest-free loans to companies, and other welfare schemes were used by the government to help the economy. This high level of spending aided the economy's revival. We should also be mindful that a major part of the rally was caused due to an influx of liquidity in the economy by foreign institutional investors (FIIs). The Western central banks, led by the US Federal Reserve, have printed a lot of money post-February to drive down interest rates and get people and businesses to borrow and spend. Between February 26 and August 5, it printed almost $2.8 trillion. After lagging in India during the previous several years, foreign institutional investors have invested a net amount of Rs 83,682 crore in Indian equities during the financial year 2020. The rise is partly a result of the influence of the West's monetary policy.
Further, the participation of retail investors in the stock market increased last year. Between December 2019 and June 2020, the number of Demat accounts rose by 3.9 million to 4.32 million accounts, a 10% rise. From when the lockdown was imposed, to June, 2.4 million new Demat accounts were opened. The rise in Demat account registrations showed that many of these retail investors were first-time stock market investors seeking a way to supplement their income during the pandemic. This might have led to a ‘Melt-Up.' A melt-up is a sustained and often unexpected increase in the investment performance of an asset or asset class, driven in part by a stampede of investors who don't want to lose out on the gain, rather than by fundamental changes in the market.
2020 started badly for the IPO markets. But after the recovery in June, IPOs have delivered one record-breaking performance after the other. Companies like Route Mobile, Mazgaon Docks, Happiest Minds Technologies, and Burger King India, among others, saw multifold oversubscriptions, and nearly all IPOs were priced at the upper end of the price band.
After a short dip in March, the Indian stock market rebounded throughout the month, led by a few stocks. Ten stocks accounted for 75% of the increase between March 25 and June 15. Pharma businesses make up the majority of these equities.
In terms of the current situation, Indian equities markets are, by any stretch of the imagination, overvalued. The Nifty 50 trailing PE ratio was over 34 times at the start of April 2021. The price-to-earnings (P/E) ratio indicates how much an investor is ready to pay to earn one rupee in profit. An investor would be prepared to spend Rs 34 for a profit of one rupee. NIFTY PE used to be in the 18-22 range, and anything outside of that signified high volatility. The India VIX, which measures market volatility from the perspective of investors, is now trading 17% higher at about 23 levels, showing strong market volatility.
These returns do not seem sustainable over the long run and it is not surprising that we have started seeing some correction and a recent example would be Sensex crashing 1700 points on 12th April 2021. The domestic indices were impacted by a significant increase in Covid-19 cases in April and clearly understand rising worries about governments considering lockdown, notably Maharashtra, which had the most cases in India.
So the issue remains: what should investors do in these uncertain times? They should begin by examining their stock allocation and, if they are just investing for the short term, reassessing the risk of volatility. When the markets correct themselves, they might also choose to invest more. Long-term investors face less risk, but they should clearly understand what they want to achieve and how they may do it through portfolio balance. To make the best investing decisions, you should seek the advice of a financial expert.
Trying to secure one’s portfolio currently would involve strategic asset allocation and making frequent changes. By keeping these things in mind, investors might avoid heavy losses and be safe during these times.