India is one of the most prominent places for foreign investors in the emerging markets to park their money. Its cheap labour, indomitable export presence and the ability to produce things at a more affordable cost, make it emerge as an economy with tremendous growth potential.
The stock market works in sync with the economy. When the economy performs good, the stock market also gets bullish or vice-versa. But what if the economy is going through a bad phase and still, the stock market is escalating to new heights every day?
If you are a movie buff, you must have seen 'Scam 92', the latest web series based on the story of how Harshad Mehta inflated the market. Back in 1992, the stocks like ACC, which were trading at a price of Rs 200 started to trade at a whopping price of Rs 9000 in a short span of time. People became optimistic about the stock market and started thinking of it as the "goose that was laying golden eggs". But all this was short-lived when the market suddenly dumped down, and all those who had invested had to face heavy losses.
In the last few months, the economy was in a bad phase due to the COVID-19 induced lockdown and yet, the stocks were plunging high every second day.
The question here is that in such a depressed economic situation when people were not spending much money, and the sales of the corporates were not growing, how come the stock market was rallying upwards?
Nifty 50 Chart from November 2019 - November 2020
So, why is the stock market rallying upwards?
A few days ago, the announcement of the pharmaceutical giant Pfizer claiming that its COVID-19 vaccine is almost 90% effective, is being considered as the reason behind the market chaos that is happening currently in India and across big countries.
However, contrary to popular belief, that is not all. The vaccine announcement is just one of the factors of the giant platter of important factors.
Let's take a look at some of the major reasons behind the current global stock market turmoil:
1. Announcement of COVID 19 vaccine by Pfizer and BioNTech
Gold, silver and bonds are considered to be the safe havens among the investors. Therefore when the market is going through a bad phase or when the economy is not performing well, then the investors start parking their money in these safe havens.
These safe havens provide mediocre returns without much risk of being defaulted or with significantly less chance of going down. But in the situation of a booming economy, the investors start redirecting these investments to the equity market again.
The announcement of the COVID-19 vaccine by Pfizer and BioNTech is one such news that the investors were craving to hear for a long time. To top it, Pfizer has also claimed that its vaccine has 90% efficiency and had a successful trial in the third phase. The company further announced to release 50 million vaccines by the end of the year.
Following this news, investors started to park their money from safe havens to the equity market once again. This trend can be seen again, as the spot gold prices fell 5% following the COVID vaccine announcement in the global markets. It is one of the most giant slides since August.
Even in the Indian market, the gold futures crashed 5% or Rs 2500 per 10 gram on MCX while the silver futures on MCX crashed 6% or Rs 4000 per Kg.
Gold Price Trend
2. Joe Biden as the new president of USA
Winning the 2020 US Presidential elections, Joe Biden has been elected to be the 46th president of the United States. As per the market, Biden being more proactive and less dominant than Donald Trump may not bring radical changes in the policies.
Indian analysts and experts carry a viewpoint that the Indian economy is poised to grow from Biden's presidency. The US-China trade war may continue under Biden's presidency, and India could be the one to gain momentum.
As per analysts, the new administration may seek to de-risk the world by reducing its dependency on China and considering the geographical advantage, cheap labour and an active potential among its people, India could be one of the significant alliances for the USA.
Considering equity, a sweet spot to park their savings, investors are optimistic on the Indian market to rally upwards, and thus they have started investing heavily.
3. Decreasing COVID 19 cases:
The economy came to a halt when the COVID induced lockdown was imposed globally. The corporates were shut down from operations which hampered their top lines. Further shutting down of all shops, malls and stalls in the containment zones acted as a final nail in the coffin. Companies had to rely on e-commerce for selling their goods.
The first quarter of major companies was severely impacted due to COVID-19. The decrease in active COVID-19 cases acts as a positive sign for the economy since the operation in containment zones will also resume.
Seeing this as a positive sign, the investors start praising the equity market by investing heavily, which in turn ramps up the stock market.
Declining active cases of COVID 19
4. A buying spree by FIIs
With the positive second-quarter results of many companies, Foreign Institutional Investors (FII) are on a buying spree in India. And this trend is likely to continue in the near future too since with the opening of containment zones and declining COVID cases, even a better result is expected in the third quarter.
India is one of the emerging markets with tremendous growth potential. As a result of which, it will continue to be one of the favourite markets among foreign investors.
Though the current scenario may be a little bullish, in the near term, one could see some ray of light from FIIs. The FIIs pumped Rs.14,537 crores in the Indian economy in October while in November, the count so far has been Rs 13,399 Crores.
5. Ameliorating Macro factors
The global markets started to rise as the world cheered for Biden. Indian equities too rose in sync with the global markets. Further, better than expected second-quarter results have improved the market sentiments to a great extent.
Rebound in GST revenues and robust power demand is driving the economy back on the track. The current market sentiments are improving, and retail investors are happily parking their money in the equities market again.
With all these positive signs, it may seem that the Indian Equity market is rebounding and is all set to touch the soaring heights again..
But it's been said by wise people - "All that glitters is not Gold". The same holds in this case also.
But what is the problem?
Indexes are indeed moving up and touching new highs every month. But this was happening even when the economy was not performing well during the pandemic.
People are following the herd mentality and are buying even at hefty valuations which is inclining up the stock prices. This can be further denoted by looking at the NIFTY50 chart. The companies are trading at very high valuations even when their sales are not increasing in the same proportion as that of their stock prices. This can be further denoted by the increasing P/E of Nifty while its EPS is declining. The Nifty which used to be traded at an average P/E of 21 is now trading at a P/E of 32 in November.
On top of this, about 30 Lacs new Demat accounts were opened during the lockdown period. This let many speculators with no prior knowledge about the market invest in stocks. This phenomenon also contributed to such a hike in the stock prices.
The situation can be better explained when penny stocks like Transglobe Foods ltd and Shree Precoated Steels Ltd with no sales, skyrocketed delivering a return of 4300% and 1300% respectively until August.
Nifty50 PE vs Nifty50 EPS
Source: Trendy line
How will it affect us?
To understand this, let us first understand the term "liquidity". Liquidity refers to the ease with which an asset can be converted to cash without affecting much of its market price. The market is very liquid right now, as we are seeing a lot of risky assets doing very well. It is due to the spate liquidity being pumped in by the Developed world' Central banks.
By looking at the US Fed balance sheet of the past few years, one can easily notice that it has pumped more money in the last six months than it ever has in the last 10 years. Now all this free-floating money is looking for good returns.
If you look at Indian bond returns, it has substantially declined over the past few months, since the number of bonds are fixed, and the people parking their money are more.
This sentiment is further escalating the market price and is thus helping corporates clean their balance sheets by raising debt and equities.
India 10Y Bond Yield for 2020
With the stock markets achieving new heights every second day, big investors might book some profits and start exiting their positions. This could severely impact the market as the stock prices will start falling down.
A panic situation would be created at this moment, and the retail investors would sell their shares which they bought at premium valuations, thus booking a loss.
Once this ray of positivity is gone, the market will then start correcting itself.
A stock market is sentiment-driven, and perhaps in a phase of the bad economy, it soars down. But due to the easy availability of financial resources, people now know that it is the perfect time to buy when the stocks are at an all-time low. What they don't know is, which stock to buy, and thus they follow the herd mentality.
Heavy speculations and unwanted & unrealistic tips float in the market and make people buy stocks even at a heavy valuation. Greed comes into play where small and new retail investors hope for some easy cash from the equity market.
But when some big sharks like FIIs, DII's or big investors start to exit their positions by booking profits, negative sentiments start hovering in the market. Owing to this, people tend to sell their shares even at very low prices, hoping they dont lose their entire money and thus book some loss.
On a safer side, one should look at a stock's valuation as compared to its industrial valuation to get a better insight. But of course by not ignoring the fundamentals of a company!