The Covid-19 pandemic has shattered economies and damaged wealth creation across the globe. The devastation was so brutal that practically no sector was spared, given the kind of dramatic reduction in consumer confidence and spending. India witnessed a 7.3% decline in gross domestic product in 2020-21. Millions lost jobs, unemployment rate sky-rocketed and thousands of small businesses were shut down across the country.
But while Covid-19 was ravaging the economy, the country’s stock markets went on to record new highs in regular intervals making financial professionals wonder as to the increasingly strange disconnect between economic wreckage and the record-breaking boom in bourses. While the combination of pandemic pain and financial-market euphoria is not unique to India, nowhere else has the contrast been so extreme.
The world’s worst coronavirus outbreak has battered India’s economy and its GDP was in the red after four decades. The events of 1979, until today, were the worst that the Indian economy saw since independence but even then, the GDP contraction was much lower at 5.2%. And yet investors continue to pour money in the bourses fuelling a 77% rally in benchmark S&P BSE Sensex and 53% rise in Nifty 50 Index over the past 15 months outpacing every other major equity benchmark index worldwide.
Stock market boom
At a time when economic activity in India has been derailed by the Covid-19 crisis, the country’s equity markets seem to be riding the second wave confidently. Both S&P BSE Sensex and NSE Nifty 50 — benchmark market indices — have been registering strong gains despite rising Covid deaths and declining economic activities.
The second wave of Covid-19 has made economists less optimistic about India’s growth prospects. Most of the rating agencies have trimmed their GDP growth forecasts for India for the financial year ending March 2022. These agencies had initially estimated double-digit growth for the Indian economy due to a low base and revival of business activities in the country after the first wave of Covid-19 in 2020.
For instance, Mumbai-based CRISIL, which had earlier pegged India’s economic growth for fiscal 2022 at 11%, has lowered its estimate to 8.2% in a worst-case scenario. Moody’s has revised the growth projection to 9.3% against 13.7% earlier. "The re-imposition of lockdown measures along with behavioural changes on fear of contagion will curb economic activity, but we do not expect the impact to be as severe as during the first wave,” the agency has said. S & P Global has downsized the growth forecast from 11% earlier to 9.8% now while Icra has revised it to 10% from 11% earlier.
The Reserve Bank of India, which had appeared optimistic during the early phase of the second Covid wave too has downsized its GDP growth projection for FY22 to 9.5% from 10.5% earlier. The latest World Bank report on global economic recovery post the Covid-19 pandemic published in early June has lowered India’s GDP growth forecast for the current fiscal from 10.1% earlier to 8.3% now.
But despite a gloomy GDP growth outlook, Indian bourses have gone on to register record highs. The benchmark S&P BSE Sensex has jumped from about 30,000 in March 2020 when the lockdown was imposed to more than 50,000 at the end of June 2021. The average monthly closing Sensex has increased from 29,648 in March 2020 to 52,482 in June 2021 – up by 77%.
Monthly closing average
And the rise in stock prices was not limited to blue chip Sensex companies alone but had spread across medium and small cap companies too. The average monthly closing index of BSE 500 has grown by more than 93% from 11,098 in March 2020, when the lockdown was imposed, to 21,463 in June 2021.
The small companies have done even better in the bourses. The average monthly closing index of BSE 250 small cap has increased by two and a half times from 1,336 to 3,472 during the period. Most of the small-cap companies have low revenues and small number of employees as compared to bigger companies. Because of their sizes, they are better equipped to face economic blockages. Aggressive and higher risk tolerant investors are attracted towards small-cap companies in the hope of earning high returns. And investors turned aggressive for quick returns following an unchecked rise in stock prices.
The story was the same in the National Stock Exchange as well. The closing Nifty 50 index has increased from 10,312 in the last week of June 2020 to 15,814 in the last week of June 2021 – up by 53.3%. The Nifty 500 index has grown by 59.4% from 8,488 to 13,533 during the same period.
What led to the stock market boom?
Stock markets act on expectation, goes the saying and Indian bourses are apparently acting as per this proverb. Stock prices have been rising amidst a devastating second wave of coronavirus showing investors faith in India’s long-term growth potential despite the immediate crisis. Many investors saw the pandemic as a natural disaster, not the kind of long-term shock generated by financial crises before. In addition, record fiscal and monetary stimulus led investors to believe that policymakers would do whatever necessary to put the economy back on a growth path. Staying at home, many saved their stimulus hand-outs and poured a big chunk of that savings into the bourses.
Investors believed that big companies would avoid severe financial damage following big help from the government – cut in corporate tax rate and reduction in interest rate. According to analysts, the market rally began in late March 2020 after the US Federal Reserve announced its first pandemic-relief measures. The relief kept coming. Nearly 20% of the dollars in circulation were printed in 2020. All the major central banks followed the Fed; India’s central bank stimulus equalled 6% of GDP. New Delhi later announced a huge `20 lakh crore package covering nearly all the sectors to counter the impact of the pandemic.
The prospect of a rebound in the economy following the vaccination drive last January gave extra pace to the market rally and the market continued its bull phase. The average closing monthly BSE Sensex increased by a whopping 2,814 points in one month after the vaccination began – up from 46,286 in January 2021 to 49,100 in February.
But beyond news of the Covid-19 vaccines, improvement in corporate financial performance also acted as a strong booster for investors’ sentiment. The financial results of Indian companies in the fourth quarter of the last fiscal have been significantly better than analysts had predicted.
Good financial results posted by major companies in the fourth quarter of 2020-21 is a key reason behind market optimism. Many blue-chip companies have seen their value rise on the stock market due to better-than-expected financial results. The strong earnings season has helped investors to look beyond the distressing Covid-19 crisis. Better corporate results are seen as the prelude to economic recovery in the near term.
Quarterly results of 2066 companies (Rs crore)
Source: Dalal Street Journal (as on June 28, 2021)
The compilation of Dalal Street Journal shows that the combined net profit of 2,066 companies increased more than four times in Q4 of FY21 compared to Q4 of FY20. Defying the spectre of demand drawbacks, the aggregate net sales of the sample companies have increased by about 16% during the period.
Another reason behind investor optimism was the rise in commodity prices. Prices of industrial commodities such as copper, steel, aluminium, lead, nickel as well as precious metals such as gold and silver witnessed a sharp surge in the international market since the middle of 2020. This prompted investors to put money in such commodities and related companies to get better returns in future.
Financial and bank stocks have been major contributors to the overall stock market growth. Although the RBI measures were primarily aimed at helping individuals and small lenders, they were expected to keep non-performing assets of banks and financial institutions off their balance sheets for the time being.
Another big thing behind the unchecked rise of stock indices was the increasing presence of mutual funds in the bourses. Small investors who fear to operate in the market on their own put in money in mutual funds which in turn come to the market.
A large number of NextGen investors, who are ready to take risks to earn a higher return on their money and yet fear to deal directly in the stock market, opted for mutual funds. Due to lower interest, bank deposits and other saving options like small savings or insurance are losing their attractions fast. Much of this gap is filled in by mutual funds. Look at its growth figures: Assets under management of AMC has increased about 24% in the quarter ended March 2021 compared to April-June 2020 quarter. The number of folios has increased by a huge 63 lakh in just nine months from 915 lakh at the end of Apr-Jun 2020 quarter to 978 lakh at the end of Jan-Mar 2021 quarter.
Mutual funds (Rs crore)
No of folios
Net asset under management
Source: Association of Mutual Funds in India
Although the sharp rise in mutual funds’ portfolios and net assets under management gave the market extra bounce, the real game changer was probably the foreign institutional investors (FII).
The FII investments are often called 'hot money' because they can be pulled out at any time and they are blamed for large withdrawals of capital from the country at the time of crisis, but this time they have emerged as important players in the Indian capital market. FIIs continue to be one of the most significant drivers of the Indian equity market. FIIs, especially the long-term funds, have found India as one of the most attractive markets since early 2000 as the Indian market has shown consistent growth over the years.
The lockdown imposed to check the spread of Covid-19 in 2020 had affected inflows of FII funds too. This was mainly because of decreasing investor confidence in economic growth and the fear of spread of the virus to villages that could harm rural growth in the short term.
FII investment in equity (Rs crore)
But with the decline in new cases and unlocking of the economy, the FIIs once again had turned optimistic about the Indian economy. The aggregate FII investment in Indian equity touched a record high of `20 lakh crore in 2020-21, the year that saw the economy battered by the coronavirus pandemic.
Forecasting stock market movement is a hazardous job since the market acts mostly on perception and sentiments rather than on ground reality. For instance, the stock market in India started rallying last year in May when economic conditions were harsher due to the nationwide lockdown. The unusual rally had puzzled stock market analysts as all indicators of economic activity had collapsed.
The present market performance is a stark contrast to real economic growth, which has suffered due to localised lockdowns imposed by most states during the second wave. Many economic indicators have also taken a big knock during the second wave. There is a strong disconnect between the stock market movement and the real economy. In its FY21 annual report, the central bank has warned about a possible stock market bubble, arguing that the price boom seen in some stocks is more than their fundamental value. Should investors re-look at their investment portfolios?