Here’s why the stock market and economy are not always in sync
MUMBAI: Indian equities continue to be on fire, with benchmark indices Sensex and Nifty touching new highs every other day.
However, a bullish stock market need not necessarily indicate that all is well with the economy.
A recent Credit Suisse analysis showed the ties between the economy and markets is tenuous at best. “Not only are market returns more P/E (price-to-earnings) than earnings per share (EPS) driven, markets and economy also have different structures,” the brokerage said in a presentation on September 13.
Markets and the economy have different structures, meaning there exists a large informal economy, large parts of the formal economy may not be listed, and a large part of the market is driven by global factors or growing penetration and share, it said.
India’s quarterly growth saw a sharp decline from 7% in the third quarter of fiscal year 2017 to a three-year low of 5.7% in the first quarter of fiscal year 2018, hurt by demonetisation and implementation of the Goods and Services Tax (GST). However, the market’s continued ascent does not reflect the pain impact of these events on the large informal sector, a key contributor to GDP.
“Normally, GDP growth and EPS growth should be in tandem. However, that correlation is broken many a time in emerging markets, partly because GDPs in EMs (emerging markets) are dominated by small, medium and micro enterprises, and larger enterprises contribute less than that in the developed world,” said Nilesh Shah, managing director of Kotak Mahindra Asset Management Co. “Recognition of nonperforming assets (NPAs) has distorted EPS growth lately.
It deteriorated of late as NPAs got recognised and accounted for in the books,” added Shah.
Also, limited clarity on GST’s impact on corporate balance sheets could delay earnings revival and pose a threat to EPS estimates of fiscal years 2018 and 2019. But the market seems to be unfazed by these concerns.
The analysis showed if one splits the BSE 500 firms based on market cap and classifies stocks by their key drivers, the results would show that 25% of the market cap is almost completely driven by global factors.
“If the global economy is booming, it would in turn have its own positive implications on the domestic economy too,” said Gautam Chhaochharia, head of research at UBS Securities India Pvt. Ltd.
Around 22% of BSE 500 companies based on market cap is driven by local macro (stocks impacted by macro factors such as export oriented firms), 11% by market share (private sector banks and telecom), and 42% by penetration-driven stories (stocks driven by certain themes such as rural consumption), showed the research.