Sensex Crosses the 50K Mark — How Promising Is This Market Swell?

An economist, an accountant and a lawyer decided to gamble… and that’s how the stock markets came into existence!

As dated as this joke is on the trading floor, one must acknowledge that describing the stock markets and indices as “barometers” of national economy is a double edged sword, considering their periodic disconnect vis-à-vis present events, coupled with an ironic ability to affect current economic perceptions at the same time.

The Sensex’s bars turned immensely (and might we add momentarily) favourable yesterday when it surged past the 50,000 mark for the first time ever. The timing on this development was most interesting taking into account a new US Administration taking over, the rage of the pandemic still ongoing etc.

But the rise in the index has far greater implications for the economy and world at large. Let us try to understand how and what factors have pressured changes into this barometric index.

Sensex and the Nifty — The Bradshaws of Indian Capital Markets

Economic indices like these are simply a statistical measure of changes in financial data. Both the above are free-floating weighted indices which makes them transparent and investable indicators of change in the listed companies’ outstanding market value.

On March 10th 2020, the 30-scrip Sensex recorded its biggest single-day fall by 1,942 points, reeling under the joint forces of the coronavirus pandemic, slumping oil prices and domestic instability (Yes Bank crisis!). Which is why the scintillating upward march of the index from 35,635 to over 50,000 now (91% jump in just over 10 months) within a span of less than a year (and no ordinary year, albeit) is a rare but significant bullish rally.

Consequently, the mid- and small-cap indices are also hovering around their all-time high levels. This is a striking departure from market behaviour a couple of years ago when the Sensex had been hitting fresh highs in defiance of the gloomy economic indicators at the time. The stock market rally at that point was considered oblivious to debilitating macroeconomic indicators (mid- and small-caps were down). Analysts branded it as a “hope trade” bubble.

So, the question remains: Is the present scenario a historical repetition or does the post-pandemic recovery of the global economy seem genuinely promising?

Drivers of Index Rise

First. US President Joe Biden’s inauguration. Market optimism is high, promises of big-scale economic stimuli abound and thus the US market’s fresh records are trickling on to ours.

Second. Big corporate earnings by TCS, Infosys, Wipro, HDFC Bank etc. that are also augmenting businesses.

Third. Impending budgetary expectations. Major speculations on the Union Budget 2021 are already surfacing with respect to recapitalisation of banks and bold reforms in boosting corporate earnings.

Fourth. Twin IPO launches by IRFC and Indigo Paints at the beginning of this year generated positive subscription numbers.

There are also many outlying causes aside from the above that have driven the index rally. Entry of new types of companies into the markets such as AMCs (Asset Management Companies) and insurance firms had set expectations rolling for their steady growth in respective segments. Integrated sectors like IT, chemicals, metals and infrastructure (not to forget pharma, amidst their receipt of massive investments last year occasioned by the demand for coronavirus vaccines) are also expected to perform well and generate steady returns, if the analysts are to be believed.

How to Interpret Valuations?

The most visible determinant is the price-to-earnings (P/E) ratio which stands at 34.4 currently. Since Sensex is largely driven by the price movement of 30 big companies, a high P/E ratio (ratio of price per share to earnings per share) such as the present could mean two things.

Either investor sentiment is high and thus share prices are on the rise; OR the prospect for growth in the future is high. Given the simmering economic conditions persisting since the last year, coupled with gradual recovery, scores of state-sponsored economic stimulus packages propelling liquidity, recent vaccine-optimism and bullish US markets attributable to changing administration, the latter is more likely to have impulsed the growth of the indices.

The Nifty50 P/E was also trending at 39.4 (a lifetime high). Coupled with that, market capitalisation-to-GDP ratio has also hit a high of 98% for the country. If this ratio goes past 100, stock markets are deemed expensive and overvalued.

FYI: Let’s also remember that large swathes of our economy are still unorganised and therefore the capitalisation-to-GDP ratio which takes into account only listed companies, may not be accurate in the Indian scenario.

In addition, based on forward earnings yield, the Bond Equity Earnings Yield (or BEER) ratio has been hovering between 1.33 to 1.5 which is also a sign of grossly overvalued markets.

And finally, the VIX or volatility index which measures market fluctuations expected over a 30-day period in the future is close to 21. For a market to remain promising and forward-looking, the VIX should ideally cool down below 20, thereby, creating the outlook of a positive growth momentum.

To “Bear” or Not to Bear?

World governments have understandably left no stone unturned into retrofitting their pandemic-stricken economies. Although heavily-endowed fiscal stimulus packages have aided in that process, but in a way, they have blinded us to economic realities, through perhaps, overinflated cues in the indices. In August 2020, the RBI Governor pointed towards this anomaly by advising investors to remain cautious of prevailing stock market exuberance, like the one witnessed today.

Interestingly, in its January Bulletin (coincidentally released yesterday), the RBI turned bullish in its forecast (in a significant departure from its earlier stance), saying that India’s GDP is within “striking distance of attaining positive territory.” The disclaimer that the views of the bulletin’s authors are not necessarily the views of the RBI only appear like an attempt to hedge.

The loan moratoriums, delayed corporate resolution processes, temporary interest-rate cuts etc. are yet to lose their touch (on indicators like debt-to-equity ratio and interest coverage ratio) and make a full-scale impact on the broader economic outlook. So better not to puff up our expectations yet, maybe?

(Originally published January 22nd 2021 in transfin.in)