THE GREAT STOCK MARKET MYSTERY
WHY THE SENSEX IS ON FIRE EVEN AS THE ECONOMY HURTLES DOWNHILL.
WHY THE SENSEX IS ON FIRE EVEN AS THE ECONOMY HURTLES DOWNHILL
On March 30, 1992, the BSE Sensex crossed the 4,000 mark for the first time. It took seven-and-a-half years to move up another 1,000 points past the 5,000 milestone on October 11, 1999. But the journey from 5,000 to 6,000 was a short one, less than four months. When Sensex hit the then alltime high of 6,006 points on February 11, 2000, India was well into the worst- ever economic slowdown. In financial year 2000/01, India’s GDP growth hit a nine-year low of 4 per cent with the January-March quarter witnessing GDP growth of only 1.76 per cent. The farm sector was facing a crisis as production shrunk. In the next fiscal, growth in the manufacturing sector plummeted to 2.3 per cent, from 7.8 cent a year ago.
Cut to 2019. The Sensex touched a fresh all-time high of 40,816 on November 20. GDP growth hit a six-year low, rising only 5 per cent, in the April-June quarter. Private investment as well as government expenditure is shrinking. Industrial output or IIP contracted 4.3 per cent month- on-month ( MoM) in September, the worst since the present series was launched in April 2012, while manufacturing output declined 3.9 per cent.
History is repeating itself, two decades apart. Surprising as it may seem, stock markets continued to scale new highs in both the cases, defying the gloomy economic indicators. “Fundamentals have been fairly weak since December last year. It has been nearly a year and this weakness has intensified in first and second quarters of this year,” says Dhananjay Sinha, Head of Strategy and Chief Economist at IDFC Securities.
According to a National Statistical Office ( NSO) draft report, household consumption in 2017/18 dipped for the first time in 40 years. The average amount spent by a person per month dropped to ` 1,446 from ` 1,501 in FY12. When consumption expenditure goes down, companies are impacted as their earnings fall and, hence, their capacity remains under-utilised, due to which jobs are cut and investments curtailed.
This sets in motion a vicious cycle where there is even lesser money in hands of people to spend, delaying consumption revival, which is necessary to boost corporate earnings and investments. Both are falling right now.
But then, why are the stock markets on fire?
‘Hope Trade’ Defying Gravity
Stock markets seem oblivious to the debilitating macroeconomic indicators. The Sensex and the Nifty have been on a roll since September 20, 2019, when Finance Minister Nirmala Sitharaman announced a cut in the basic corporate tax rate from 30 per cent to 22 per cent and for new manufacturing companies from 25 per cent to 15 per cent. The effective rate for companies came down to 25.2 per cent, including all additional levies, a benefit of nearly 5 per cent.
The very same day, markets witnessed the biggest intraday gain ever and the Sensex closed 1,921 points up, topping the 38,000 level. The Nifty jumped 570 points to end just short of 11,300.
In effect, the current market rally began with Sitharaman’s corporate tax cut announcement and there has been no stopping since then. Markets continue to touch new highs every few days. The rally that was expected to end post-Diwali is continuing despite the deteriorating economic signals.
Umesh Mehta, Head of Research, Samco Securities, explains this by saying that the stock market is a forwardlooking machine. “And stock prices reflect not what has already happened but what is expected in the next three to four quarters.”
G. Chokkalingam, Founder and Managing Director, Equinomics Research and Advisory, agrees that stock markets discount the future. “The dichotomy (of dwindling economy and rising stock markets) is there because the market believes that things will improve in the short to medium term. It assumes that in 6-12 months, economic parameters will improve, corporate earnings will grow and that is why money continues to come in,” he says.
In market parlance, this is called ‘Hope Trade’. “There is also a lot of hope that the government will announce more sector- specific measures to ease corporate stress,” he adds.
Narrow Rally
The rally in the benchmark indices, however, is neither secular nor broadbased. The benchmark indices, the Sensex and the Nifty, represent the strongest 30 and the strongest 50 firms’ fortunes, respectively. These are companies that have delivered strong numbers despite the weak economic environment. Investors look for safe havens during bad economic cycles. Dig deeper and the mid- caps and the small- caps tell a different tale. The current quantum of fall in the mid- and small- cap space has been the worst in the last two decades. The combined market cap of Group B shares (mid- caps and small- caps) on the BSE fell 63 per cent from March 2018 levels; it had gone down 62 per cent post the Lehman crisis.
The current combined market cap at ` 7.64 lakh crore is the lowest in the last one decade, indicating that this space has not benefitted from the current rally. “Mid- cap and small- cap stocks do not typically witness institutional participation and are very volatile. They may bounce back in 18 months if we go by historical evidence, though there is no rule,” says Chokkalingam. This is because beyond a point, when large- caps continue to rally, they become so expensive that investors find them less attractive. “At that point, when any investor makes a significant move towards midor small- caps, the whole market jumps in their favour,” he adds.
The performance of some large-caps has been aided by the reduction in
the number of players in sectors such as aviation, media, nonbanking finance and telecom. As a result, the surviving players have been rewarded by the stock markets for their robust business model and steady growth rates.
Ajit Mishra, Vice-President Research, Religare Broking, says the returns in the benchmark indices are largely skewed towards the outperformance of just eight to 10 heavyweight companies. “These companies remained the least affected by the slowdown and their continuous market share gains while maintaining profitability has led to their outperformance,” he adds.
These top performers include NBFC giant Bajaj Finance, which has given 79.8 per cent returns (in the November 15, 2018, to November 14, 2019, period), followed by Bajaj Finserv at 62 per cent, Kotak Mahindra Bank at 37.5 per cent, Nestle India at 36 per cent and ICICI Bank at 34.8 per cent.
At a time when NBFCs are reeling under a liquidity crisis, Bajaj Finance reported a 63 per cent rise in net profit in the second quarter of the fiscal, led by growth in consumer, rural and mortgage segments. Given its top credit ratings and strong parentage, Bajaj Finance is among the handful of companies that have not only navigated the NBFC crisis successfully but are also among the stocks driving markets up every day.
Samco’s Mehta agrees that the current rally has been driven by large corporations, which have remained unscathed or have felt minimum impact of the ongoing economic slowdown. “Indices reflect earnings growth and profitability during the quarterly results. This has led to concentrated buying patterns in indices, which has caused the bourses to touch all-time highs. This reality, though in contrast to the glum economic scenario, has led to the Nifty50 stocks moving higher,” he says.
GDP numbers are largely representative of agriculture, manufacturing and services growth, which have their individual trajectories, says Mehta. While manufacturing and agriculture have not been encouraging, some pockets of services like banking and finance are showing quick recovery.
“GDP numbers are a larger reflection of economic activity as a whole, comprising the above verticals. But the stock market, in particular the Nifty, is moving on the strong delivery of quality companies as the Street is looking for safer havens for investment in these uncertain times. This has led to divergence between the bourses and the economy as a whole,” says Mehta.
Mid- and Small- caps Trail
The divergence is not only between the bourses and the economy. Within the bourses too, mid- and small- caps have not been able to benefit from the current rally.
Since September 20, when the current rally began, the BSE Midcap Index has gained only 680 points while the small- cap index is up just 200 points, as per the closing on November 20. The Sensex has, however, gained over 2,000 points during the last two months. That explains why investors continue to flock to the large- caps.