Markets in India are broadly mirroring the trend elsewhere, effectively highlighting the disconnect between financial markets and the real economy across the world.

Undeterred by the pandemic, projections of an unprecedented economic contraction and border tensions, India’s stock markets have staged a remarkable rebound. While the Sensex has gained 40% since hitting a low of 25,981 on March 23, markets have continued to climb since June 1, even as the number of daily new Covid-19 cases rose from around 9,000 in the first week of June to over 20,000 in the first week of July.

Will this sustain? Markets in India are broadly mirroring the trend elsewhere, effectively highlighting the disconnect between financial markets and the real economy across the world. Investors appear to be focusing on the easing of some short-term tail risks, and placing their bets on central banks’ return to monetary-policy easing, ignoring the economic slump and the rise in global poverty. From a medium-term perspective, the fundamental risks to the global economy are actually getting worse, with the pandemic nowhere near ending. The big concern is the unrealistic valuations, given that FY21 is a washout in terms of earnings for companies across sectors. There are also red flags regarding fresh non-performing assets for banks, which may begin to show up after the moratorium period ends on August 31. Experts feel that a lag in economic revival, demand in the economy and reinstatement of income levels may lead to stress in all segments — corporates, MSME and retail in the quarter ended December 2020.

How have stock markets behaved globally?

In the US, the June quarter, which saw stock market gains of 18%, ended as the best performing quarter from American indices since 1998. This came amid concerns over new coronavirus cases spreading to US heartland states and a worsening trade stand-off with China. The S&P 500 and Dow Jones Industrial Average rose by over a quarter, and the Nasdaq by over a third during this period.

European stocks actually outperformed the S&P 500 in June. Chinese stocks have also surged, with both the CSI 300 of Shanghai- and Shenzhen-listed shares recording a sharp recovery, supported in recent days by state-run media encouraging retail investors to buy stocks. The Nikkei 225 in Japan also gained over 35% in the same period.

Why are markets going up?

The near 40% gain in India’s benchmark indices — BSE and NSE — since the March 23 low came even as retail investor sentiment was weak and individuals held on to cash amid uncertainty. The rise, interestingly, has not been limited to premier indices, with mid-cap and small-cap indices rising 39% and 44% respectively.

While the gains in stock markets worldwide have been puzzling, there are some answers. The first is the ample liquidity in the market. Following the dip in economic activity and fall in markets in February and March, the US Federal Reserve announced a liquidity injection and bond-buying programme of more than $3 trillion, with a promise to do more. The decisive action is what differentiates the response of central bankers to this pandemic from its sluggish, delayed response during the 2008 meltdown.

In India, the Reserve Bank of India cut its key policy rate by 115 basis points over the last three months and announced a liquidity injection of around Rs 8 lakh crore in the financial markets since its first announcement on March 27.

Market participants say that with so much liquidity worldwide and very few places to go, a lot of money is finding its way into the stock markets, thereby lifting it.

India too, has witnessed jumping FPI (foreign portfolio investment) inflows after the record net outflows of nearly Rs 62,000 crore from the Indian markets in March 2020. Between May and June, the FPIs have invested a net of Rs 36,400 crore into the Indian equities.

As for DIIs (domestic institutional investors), they invested a net of Rs 72,528 crore into Indian equities in February and March, and over Rs 16,000 crore between May and July.

Some participants feel that a near halt in real estate investments and increase in household savings on account of the Covid-19-related uncertainty has also been instrumental in money finding its way into the stock market. On the economy front, a better-than-expected revival in automobile sales in June over May, faster recovery in rural India, and expectations of a good monsoon have fuelled the bull run.

What explains the behaviour of retail investors?

A look at some key numbers: if the average investor account addition at Central Depository Services (India) Ltd for the year 2019-20 was 3 lakh, CDSL added 19.6 lakh investor accounts in three months between April and June, at a monthly average of over 6.5 lakh.

Stock exchange data also shows a sharp jump in market share of non-institutional investors (retail investors) participation in the cash segment; this is the highest since August 2009. The share of NIIs, which stood at around 50% in FY20, jumped sharply over the last three months and rise to 68%.

A senior fund manager with a leading fund house said that the share of NIIs in cash segment has grown at a time when cash volumes have doubled over the last two years. “The FIIs and DIIs have been sidelined by retail investors who have taken the centerstage,” said the fund manager. He cautioned, however, that “it is not a healthy trend as the delivery volumes are low and that reflects speculative tendencies in the market”.

Many feel that there is a growing sense among retail investors that since the fatality rate of Covid-19 is low, this suffering will be short-term and when the economy bounces back they may not get the opportunity to buy in the market at current levels. “Believers of markets have the faith that Covid-19 also will pass and then liquidity will push stock prices up,” said C J George, MD, Geojit Securities.

Mutual funds however, have seen a decline in flow of new investors. While new SIP registrations for FY20 stood at a monthly average of 9.8 lakh, in the month of April and May it fell to a monthly average of 7.8 lakh. Senior officials at mutual funds say a sizeable number of investors who used to transact physically were not able to do so during the lockdown, but things are improving since the branches reopened.

Will the momentum sustain?

The big concern for the market is around the valuations. While FY21 is a washout in terms of earnings for NIFTY 50 companies, experts say that based on projected earnings for FY22, the markets look richly valued. “At projected EPS of around 500 for NIFTY for FY22, the price-to-earnings ratio comes at around 22. That is rich valuation and is the biggest concern for the markets as of now,” said Pankaj Pandey, head of research at ICICI Securities. He further added that while Covid-positive cases are rising, “if we were to go by death rates, the peak of the problem is behind us”.

Another concern that may come up is non-performing assets for banks, which may begin to show up after the moratorium period ends on August 31. Experts feel that a lag in economic revival, demand in the economy and reinstatement of income levels may lead to stress in all segments — corporates, MSME and retail in the quarter ended December 2020. “As the moratorium period ends on August 31, we may start witnessing the early warning signs for rise in NPAs beginning October 2020 and by December it may grow substantially,” said a banker who did not wish to be named.

However, there are certain positives that may keep the markets to do well. A good monsoon holds the key to gain in momentum in rural recovery and growth in demand during the festive season.

A positive in the current rally is the participation of broader indices — mid-cap and small-cap —alongside Nifty and Sensex. There is a sense in the market that if a medical solution to Covid-19 comes over the couple of months, then there may be a big rally as there is a huge amount of liquidity sloshing about in the market.

While retail has entered in Indian market and other markets in a big manner, market participants say that even FPIs and DIIs will continue to invest as there is liquidity in the market and there is a consensus that NIFTY earnings for FY22 would be 30 per cent higher than those for FY20. “This means an additional upside of 30% is there over the next two years,” said a fund manager.

The fact that interest rates are at a decade’s low and may remain so, the decline in interest offering on term deposits by banks and on small savings instruments will result in an outflow of funds from debt to equities by domestic investors. Also, since globally the interest rates are low, FPI money will also move into debt and equity markets of emerging economies that may lead to a further surge in stock markets.

However, there are real risks on account of the pandemic raging longer than expected and delays in a medical solution, alongside trade and geopolitical tensions involving the US and China, and China’s repeated run-ins with its immediate neighbours, including India.

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