Beware: Your share price riches are built on shaky foundations

The real reason markets have been rising since April is the copious availability of cash in the global economy

Pawan Gupta (name changed), a 31-year-old professional based in Bengaluru, had over Rs 2 lakh invested in the stock markets before the coronavirus started to grip the world in earnest in March. Share prices collapsed, and he saw the opportunity to tank up, which he did by buying a further Rs 1 lakh worth of stock.

However, earlier this month, with stock markets soaring, he sold all his shares, at a hefty profit of between 20 and 40% in less than a year. In other words, Pawan is a smart investor who swears by that ancient piece of market wisdom: Be greedy when everyone around you is scared, and be scared when everyone around you is greedy.

India's benchmark stock indices – the Nifty and the Sensex – have been touching historic highs every other day this month. Shares across the world are rising: Hopes for a vaccine to end the pandemic and the emergence of some political stability in the United States are only part of the reason.

The Ticker Tape, an online information platform for Indian stocks, showed its so-called market mood index hit 77.42 earlier this week – denoting extreme greed. Anything above 80 is classified as ‘high extreme greed’ meaning that investors should think several times before buying shares. Globally, CNN's fear and greed index stood at 82 – a high extreme greed situation.

Pawan, like many analysts, is expecting the markets to fall, and fall sharply. After all, it doesn’t make sense for shares of companies to be rising when the economy in which they generate profits is struggling in a big way, with manufacturing and consumption both down.

Stimulus money in markets

The real reason markets have been rising since April – a month after the smart Pawan bought more shares – is the copious availability of cash in the global economy, thanks to huge stimulus packages announced by countries across the world.

By May 2020, central banks and governments had unveiled an estimated $15 trillion of stimulus, nearly a fifth the size of their economies. The governments expected this to stimulate demand for goods and services, boosting growth to counter the chilling effects of the pandemic.

But instead, a sizeable chunk of this money found its way into stock markets globally, big parts of it into emerging markets like India, where long-term growth is always more promising than in developed countries. This diversion of funds means that foreign institutions have parked an unprecedented Rs 1.26 lakh crore in the Indian equities. This is more than the country’s entire food subsidy bill.

“The larger implication will be for the monies which have moved from stimulus cheques to stock markets, leading to an inherently inefficient economic cycle, and sooner or later governments will have to steady that ship,” says Anubhav Srivastava, Partner, Infinity Alternatives.

Benchmarks surge, consumption dips

The benchmark indices have climbed by a dizzying 77% in India since they touched the lows of March 23. In the first six months of the financial year the economy shrank by Rs 11.16 crore compared with a year earlier, while investor wealth – measured by the value of all companies that trade on the stock exchange – rose by Rs 81 lakh crore.

Globally, stocks are suddenly more valuable than real economies by nearly $20 trillion.

This stock surge has widened income gaps. When people across India took big pay cuts, the top five billionaires in India, thanks to the frenzy in the markets, increased their wealth by $59.34 billion, according to Bloomberg Billionaire Index.

To be sure, this is not a new phenomenon. Markets have mostly moved in the opposite direction of economic growth in the past 11 years. And then, there is the argument that investors are actually buying shares based on expectations of company profits six months down the line. But the degree to which Indian shares have overheated is the problem, especially as there is no clear sign of an economic recovery.

Worrying valuations

The clearest indication of a bubble waiting to burst is a metric that investors normally worship: The price-to-earnings (or PE) ratio. This is the amount an investor pays as a share price for every rupee of profit the company generates.

This now stands at a crazy 32.84, a 110% increase over March. To put it in perspective, investors – both small investors and the big institutions – are ending up paying double for stocks at a time when the economy is in tatters. The average PE ratio for India over the last twenty years is 19.67.

This ‘miracle’, driven by foreign institutions channelling easy money into stocks, makes small investors vulnerable. The big guys – the institutions – are known for constant churning. And retail or small investors as a class are known for holding shares well beyond their sell-by date.

They have had a bad time of it on several occasions, taking a hit in successive bank bailouts, including those of YES Bank and Lakshmi Vilas Bank. There’s every chance they will be on the wrong side of this bursting bubble.

One way to avoid this fate is to study what the biggies are doing.

“Investors should keep an eye on institutional trading numbers for an early indicator of a shift in financial markets,” says Anubhav Srivastava, Partner, Infinity Alternatives.

Sven Henrich, Founder, Northman Trader, in one of his latest blogs says: “A bubble bursting will only be known in hindsight, not in advance, but we can certainly assess risk versus reward.”

Most analysts expect a small market fall towards the end of the year as traders in foreign institutions go away on holiday, and a big fall after the Budget, which
has been underwhelming in recent
years, and after poor quarterly company results. By that time, though, they see the Sensex, ticking up a further 2% from current levels.

There may still be some money to be made out of riding this ‘fake’ wave driven by global giants, but the reckoning could be coming.