JOIN USWhy is the stock market going up when the economy is going down?
The total collections of the goods and services tax (GST) between March and July stood at Rs 2.73 lakh crore. This is 34.5% lower than what the government earned during the same period in 2019.
The stock market index Nifty 50 has rallied by 53% to 11,648 points between March 23 and August 28. It had touched this year’s low of 7,610 points on March 23.
So, what’s the point in comparing the Nifty 50 with GST collections? The GST is basically a tax on consumption. If the GST collections are down by more than a third, what that basically means is that private consumption is down majorly.
When consumption is down, companies’ earnings are bound to take a beating. Take the case of two-wheelers and cars. When people don’t buy as many of them as they used to, their production takes a beating. When that happens, it has an impact right down the value chain. It means lower production of steel, steering, glass, tyres, etc. A lower production of tyres means a lower demand for rubber. Lower production on the whole means lower demand for power. Industrial power largely subsidises farm power and home power (where power is stolen). If industrial consumption goes down, the losses of state electricity boards go up. When this happens, their ability to keep paying power generation companies goes down. When these companies don’t get paid, they are in no position to repay loans they have taken from banks.
Many people buy two-wheelers and cars on loans from banks and non-banking finance companies. When the buying falls, the total amount of loans given by banks also comes down. When banks don’t get enough loans, they need to cut interest rate on their deposits.
When this happens, people who are saving towards a goal, need to save more. This means they need to cut down on their consumption. Further, people who are largely dependent on interest from bank deposits will see their incomes fall. This means, they need to cut down on their consumption as well. So works the vicious cycle.
This cycle will also lead to a fall in companies’ earnings. A Business Standard results tracker for 1,946 companies reveals that the sales of these companies for April to June 2020 were down 23.1% compared to what it was in the same period in 2019. The net profit for these companies was down 60.8%.
The stock market does not wait for things to happen. It discounted for this possibility and the Nifty fell by 32.1% between end-February and March 23. The market was adjusting for an era of falling company earnings. But it didn’t stay at those low levels and has rallied by more than 50% since then.
The trouble now is that the valuations are way off the chart. The price-to-earnings ratio of the Nifty 50 index, as of August 28, stood at 32.92. This means, investors are ready to pay close to Rs 33 for every rupee of earning for stocks that make up the Nifty 50 index. Such a level has never been seen before. Not during the dotcom bubble era, not even during early 2008 when the stock market rallied to its then highest level.
Why has the stock market jumped so much? Does this mean that companies’ earnings will jump high in the near future? Not at all. The Covid-induced recession is not going to go anytime quickly. Also, the pandemic is now gradually making its way into rural India.
So, why is the stock market rallying? 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. The Federal Reserve has printed more than $2.8 trillion between February 26 and August 5. Some of this money has made it into India.
During this financial year, foreign institutional investors have net invested a total of Rs 83,682 crore into Indian stocks, after slacking off on India over the last few years. The stock market rally is clearly an impact of the easy money policies being run in much of the West.
Further, the participation of retail investors in the stock market has increased this year. Between December 2019 and June 2020, the number of demat accounts rose by 3.9 million to 43.2 million accounts, a 10% rise. In fact, just between end-March, after a total lockdown was introduced to tackle Covid-19, and June, 2.4 million new demat accounts were opened.
The latest monthly bulletin of Securities and Exchange Board of India, the stock market regulator, points out: “We have seen a huge surge in participation of retail investors in the equity market in the last few months. The fact that there is also a surge in opening up of demat accounts suggests that many of these retail investors are perhaps first-time investors in the stock market.” With after-tax return on bank fixed deposits down to 4-5%, when inflation is close to 7%, these investors are coming to the stock market in search of higher returns.
The question is, with the stock market at all-time high valuations, will their good times last? Or once the dust settles, will another generation of investors come to see investing in the stock market as gambling? On that, your guess is as good as mine.