Why the Stock Market is Up when the economy is Down!


4 min read
Why the Stock Market is Up when the economy is Down!

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With over 1.6L cases India became 10th worst-affected country from Covid 19 and the economy is headed for its fourth recession since independence, which may also prove to be its worst. Crisil expects real gross domestic product to contract by 5% in FY21 and forecasts a 10% “permanent loss of GDP” as, over the next three years, India is unlikely to move back up to the levels of GDP that would have been achieved under pre-Covid growth scenarios. 20 lakh crore stimulus package seems to be a flop show as experts estimates the fiscal cost of this package is merely at 1.2% of GDP not 10%.

Despite relative easing of restrictions in the latest phase of the lockdown, economic activity continues to be disrupted. The zone-wise % contribution in GDP is a bit scary.

Rising tensions between India and China is working as a catalyst in economy downturn. The standoff began on May 5, when troops clashed on the banks of Pangong Tso leaving scores of soldiers on both sides injured.  China has placed about 5,000 soldiers and armored vehicles within its side of the disputed border in the Ladakh region and India is adding a similar number of troops as well as artillery guns along the border to fend off the continuing incursions by Chinese army.

EMI Moratorium extension is of-course not a 'Free Lunch'. Borrower need to payback the entire money with interest without fail. No doubt NPA levels would be much more higher than expected post Moratorium ends as small business may go bust due to zero revenue in the entire last quarter. Some of the industry like hotel, Aviation, real estate, automobiles, eCommerce are severally impacted. Indian banks may see a rising need for capital as credit quality of borrowers weakens, leading to a jump in credit costs. Credit Suisse estimates the need for additional capital at $20 billion (about Rs 1.5 lakh crore) over the next 12 months.

Why Market is up?

Looking at the stock market these days, NIFTY 50 surged almost 25% from its March 23 bear market lows, COVID-19 appears to be not much more than a short-term disruption. The economy, however, tells a far different story of steepest GDP contraction. Clearly, two different narratives are being told by the stock market and the economy. The question becomes: which one is accurate?

Dr Anthony Fauci, US Infectious Diseases expect is confident that vaccine could be ready by end of this year. The stock market is too optimistic about an economic recovery.

"Anything that is expected doesn’t move the market. Over 90% of the value of stocks is dependent on earnings more than a year in the future. The market is very forward-looking. ’Investors weren’t thinking six months ahead; they were thinking a year or two ahead, by which point the virus would probably have been brought under control. We’ll have a U-shaped recovery, not a V, but the market is looking at the upper part of the U".  

- Jeremy Siegel, Professor of Finance,  University of Pennsylvania in Philadelphia

The biggest beneficiary of current pandemic is proved to be Mukesh Ambani. Over the past few weeks, Jio Platforms has sold around 17.12% stake to raise Rs 78,562 crore. The oil-to-telecom conglomerate is expected to list Jio Platforms in global stock markets (Overseas listing) over the next 12 to 24 months. RIL stock rally also helped Indian indices to lift further.

The current market’s overconfidence seems to be driven by the RBI and governments widespread interventions.

During this COVID-19 pandemic, the economy is suffering severely, at least in the near-term; therefore, the stock market’s resilience seems illogical. One reason for the resilience may be investors’ behavioral biases, which are leaning decidedly bullish. When investors are overly confident about the future, they tend to look for evidence that affirm that bias, such as economies reopening and vaccine progress.

What else can be done?

1) India's Repo rate is at 4% and Bank's corporate India lending rate at around 8-9%. RBI still has a room of 400 basis pts rate cut to fill the gap where it can also lower corporate lending by even 900 basis pts.

2) India's dead assets can be alive and can be used significantly in economic recovery. For example: Value of India's enemy properties stands at Rs 1 lakh crore containing around 9000 properties which can be en-cashed and sales proceeding can be well used to fund GDP growth.

3)  Indians own between $1.5 to trillion of gold in their almirah. This gold is savings of centuries and unfortunately all are unaccounted. How to we bring this unaccounted gold into mainline economy so that we can support our GDP.

In the Great Depression of 1929 US FED needed to print money. For printing money you need gold and for gold  you need money. In 1933, US president Franklin D. Roosevelt nationalized all the gold owned by Americans. He passed the law criminalizing owning of gold in the entire territory of US. It was not headline, it was last page new and anybody hardly remember. Citizens surrendered their wedding rings at below market price so that US government can print more $. They won and they are the super power.

For business leaders, it may be advisable to look well beyond the overconfidence and optimism of the stock market rally and the pessimism of the second-quarter economic data because all the companies will have tepid top line and so the profits.

If someone is interested to buy stocks in this market the concentrate more on 'Debt' and 'Pledge shares' of the company. Both must be zero of close to zero because in this scenario, these two forces are so powerful as they can shut the operations even with having good financials.

How sustainable the stock market rally really remains to be seen.

Thanks!

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Akshay Seth
Research Analyst (SEBI Regd.)
Linkedin | akshay.equity@gmail.com

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