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Friday, January 22, 2021

When economy looks gloomy, Indian stock markets are going up. Why?

Stimulus packages - aid packages worth 8 trillion dollars, Interest rate cuts and the reduction in production costs are contributing to increased demand for the existing stocks.

Since March 2020, Indian stock market almost doubled in value (NIFTY 50). However, Indian economy projections are gloomy. This situation represents raises a question “Why is Indian stock market going up?”

Summary of the Indian stock market recovery

NIFTY 50 represents the performance of India’s biggest companies in the National stock exchange. It started pretty flat from the beginning of the year. But when the news of COVID 19 hit towards end of the March 2020, the stock market went back to 2016 levels. Since that time, the index recovered pretty steep from its lowest on the day India entered the lockdown (March 24 2020). This does not make sense especially given the raise in the number of cases India is witnessing and the Covid 19 vaccine is yet to prove its efficacy. Plus India is the middle of one of the biggest civil protests it witnessed in recent times. 

Indian stock market going up
Nifty 50 – 2020 Performance. Pic – Google Finance.

To understand this phenomenon, you have to first understand, the stock market is not the economy. The economy is measured by Gross Domestic Product (GDP) and the stock prices do not indicate the GDP. Having said that, what does the stock market represent and how do we explain the rise in India’s stock market? 

It’s not just the Indian stock market that’s rising and rising. Almost all stock markets across the world are in perfect correlation with each other.

What makes the recovery of stock market significant this time?

What makes this growth in the stock market different from other periods of growth is how fast is this recovery. Take for example, the 2009 recession. For the stock market to recover to the peak of 2009, it took almost 4 years. If you take any window in between to compare the levels of the stock market, the cycle will last at least 1 year. But not this time. In less than 1 year, the stock market almost doubled from its low in March 2020. 

Nifty 50 Vs Dowjones- 2020 Performance. Pic - Google Finance.
Nifty 50 Vs Dow Jones- 2020 Performance. Pic – Google Finance.

Why this growth looks surreal?

By the end of 2020, Indian economy is expected to contract by almost 10 percent. Then why in the world, the stock market is rising? This is both mysterious and surreal. To understand this we have to understand basic supply and demand economics. If there is more demand for apples than sellers can sell, the prices will rise. The same logic applies for stocks. Between March and December 2020, the re is a huge inflow of money to buy stocks from domestic and foreign institutional investors. An institutional investor is someone who invests in stocks just like any individual but they have huge money to invest on behalf of their clients. But then, why did institutional investors buy so much stocks when everything looked gloomy? 

What can explain this growth in Indian Stock Market?

The answer lies in three things. One – Stimulus packages. Countries around the world, announced aid packages worth 8 trillion dollars. This money has to go somewhere right?  Second – Interest rate cuts. When the money is cheap to borrow , people will borrow and will invest in assets. and the third is reduction in production costs projecting increased profit margins. Together these three factors are contributing to increased demand for the existing stocks. The biggest worry is that this increase in stock prices is not driven by a healthy increase in the overall economy or productivity. Some economists caution this could be another “Irrational exuberance”.

 

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