Stocks

How long will the State-sponsored rally sustain?

KS Badri Narayanan | Updated on July 11, 2020 Published on July 10, 2020

From US to China, govt wants the stock markets to remain bullish

At a time when the entire world is grappling with the Covid-19-induced economic slowdown, China, as usual, surprised the stock markets by advising investors to rush in to buy stocks.

According to global media, State-run China Securities Journal ran a front-page editorial which argued the foundations for a ‘healthy bull market’ had strengthened over the past three decades, and pointed out that the ‘wealth effect’ from rising share prices would stimulate consumer spending. State-owned Shanghai Securities News, too, ran a story with the headline ‘Hahahahaha! The signs of a bull market are more and more clear’.

Following this, the Chinese market went ballistic, as its stock indices surged to the biggest one-day gain in half a decade; Monday’s surge alone added more than $460 billion to Chinese stock values.

Thanks to China, global stocks too joined the party, making handsome gains. Though it was not clear whether Chinese central bankers indulged in active buying of stocks or bonds directly, local investors got the necessary signal that the Government may actually spur the markets through various means.

Greenspan put

This type of State-sponsored rally is not new to the world markets. The father of the risk-on rally is none other than former US Federal Reserve Chairman Alan Greenspan. During early 1990s, Greenspan and the US Fed kept interest rates very low to aid the economy.

Taking advantage of the low interest rates, traders built long positions, and later even risky bets, assuming the stock markets is just a one-way route. Traders who went long on stocks also bought a put option to protect themselves from any volatile swings, which was widely known as the ‘Greenspan Put’.

This famous strategy culminated in the dot.com bubble of 2000.

Quantitative easing

The Greenspan put was followed by the famous quantitative easing (QE) programme of 2008 by the US Fed, which was later adopted by central bankers across the globe. Since then, these programmes kept coming — QE 1, 2 and 3. According to Investopedia.com, the US Fed had started a QE programme by increasing the money supply by $4 trillion. The Fed has expanded its balance sheet from $870 billion in 2007 to around $7.2 trillion now. The goal of this programme was for banks to lend and invest those reserves in order to stimulate the overall economic growth. Again this resulted in easy liquidity, pushing up prices of most assets across the globe.

LIC, a defensive player

While in India, there is no such ‘action through direction’ by the central bank, it is widely believed that often Life Insurance Corporation of India comes to the rescue of the stock markets, mostly in the form of a defensive player to arrest big slides. In the process, some value is added in its portfolio. It also participates in the Government’s disinvestment process.

So, how does one cope with this liquidity-driven rally, which lacks fundamental strength of economic growth? Excessive liquidity is causing asset price inflation with hot money flowing through exchange-traded funds (ETFs). While Nasdaq hit an all-time high, thanks to easy money, almost all other major indices such as Dow Jones, S&P, Nifty, and Sensex gained about 35 per cent since their March lows.

So, in this hope-driven rally that economies and earnings will soon rebound sharply, one has to be very careful. If these hopes are belied, the fall could be massive, and the road to recovery, long.

It is better to concentrate on quality large-caps, while investment in mid- and small-caps can be routed through mutual funds.

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Published on July 10, 2020
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