Big disconnect between real economy, market: UK Sinha

Sensex was at 25,600 on March 23, 2000 (on February 25, 2020, it was 40,000, and one month prior to that, it was at 42,000 on January 16). People only remember the fact that the markets have doubled. My worry is that the market has doubled, but what about the larger economic scenarios and where is the supportive data even for company earnings?

We are talking about the Indian economy, which is going down by about 9.5 per cent during FY21 as projected by multilateral agencies and by 7.7 per cent as estimated by the government. Everyone agrees that FY21 will be year of contraction. The forecast for FY22 is that growth will be around 5.4 per cent. Going by these forecasts, the size of our economy on March 21, 2022, will be less by about 5 per cent from where it was in March 2020. Only in March 2023 the economy will be near where it was in 2020.

There are similar forecasts for the global economy. During calendar 2020, GDP contraction was estimated at 4.3 per cent, while it is expected to grow at 4 per cent in 2021 and 3.8 per cent in 2022. So, the global economy will lose two years and the Indian economy will lose three years prior to reaching pre-Covid levels

Take a look at the numbers on market earnings. As on January 15, 2021, PE Ratio is closer to 40. The forward number is also closer to 33. These are historically high numbers and difficult to sustain. Except for one country — South Korea — nowhere else are the numbers in this range. Even emerging markets’ MSCI index is much less than that. The economy is in contraction, but company earnings show a different picture. This is because of the unprecedented stimulus amount (which is several times more than that during global financial crisis), which is further added by the actions of central banks across the world that have reduced interest rates and bought government as well as private sector assets worth trillion of dollars. Most of this money is coming into the capital market.

Given the Covid situation, such measures may be justified, but the impact is that investment is not taking place and these funds are getting into asset classes. In the past, these were getting into sectors such as housing. This time, it has not happened, except for one or two countries.

So, most of the money is getting into the capital market, both debt and equity. We are seeing the impact: interest rates are low and inflation is low. There is obviously a major disconnect between the real economy and markets. One famous Hedge Fund investor used the example of investors behaving like frogs in boiling water. Put them in a pan and slowly start increasing the temperature. They think there is no harm in being in this water, there is no risk in this water. Gradually, the temperature will rise and the final outcome will be bad. Another example being given is that you give paracetamol to somebody and then start measuring his temperature.

The real facts about Indian economy and global economy are being masked by the liquidity, which is driving the market. Since it is helping in the rise of asset prices, the question to be asked is if it is sustainable. Going by the past history and state of the global economy, long-term skirling of potential growth, lack of investment, and rising inequality indicatethat it is not sustainable in the medium term. The most benign thing that is going to happen is that the curve will start flattening rather than rising at the current pace.

Indian regulators are doing a very fine job. However, it is important to note that besides this huge liquidity coming in, there have been several forbearances on the regulatory front, and in Covid-like situation, it was perhaps justified — for example, recognition of NPA in the banking sector or in NBFC sector, moratorium on loan re-payments, suspension of fresh insolvency cases, among others. There have also been measures relaxing corporate governance norms.

It is time for everyone to think when regulators will start unwinding. Things can’t go forever in this manner, but care has to be applied that actions should be orderly and not lead to disruptive results. For example, whenever special accommodative measures are reversed, markets get jittery.

Remember the ‘taper tantrum’? So, it has to be planned carefully now rather than postpone it to a future date. Regulators have to give a signal that they are reviewing Covid-related special dispensations A lot will depend on how the government and regulators look at unwinding and normalising the regulatory frameworks. One must recognise that normal regulatory regime can bring out surprises about companies facing solvency issues.

In the US, filing for insolvency protection has already gone up substantially. At the same time, forbearance should not allow unsustainable companies to survive on the back of support from the banking sector in the name of special Covid treatment.

There was monthly substantial increase in new demat accounts in 2020; regulators should be on guard on the type of assurances that are being given, what mis-selling is taking place, and where financial products are being sold in a fit and proper manner.

Also, there have been instances of brokers mixing client money with their propriety money in violation of SEBI’s instruction, or MFs crossing prescribed exposure limit, leading to serious consequences for investors. The supervisory regime has to be extra cautious and proactive.

When Sensex reached 35,000, MF investors started withdrawing money. Prior to that, monthly inflow used to be in the range ₹5,000 crore to ₹6,000 crore. Since July 2020, it has started becoming negative and, in November and December, the net negative inflow in equity schemes has been in the range of ₹13,000 crore per month. But FPI investment in equity market has been $32 billion between April 1, 2020, and January 15 this year.

However, a major portion of this money is from passive investors who invest in global or regional indices. Besides, the US economy is expected to start doing well again this year. If advanced economies start doing well, then some of the FPI flows might see a reversal of trend. Also, there has been some rise, in percentage terms, in participatory notes.

My feeling is that ordinary investors should go on investing in a systematic manner. Our SIP numbers are more than 4 crore now, we have over 8.5 crore investors in the mutual fund industry, which used to be less than half six years back.

I am worried about those investors who are guided by FOMO (Fear of Missing Out) and here my caution would be those who are taking leverage to buy assets, especially equity assets. There are people who invest in the market and they even borrow for investing. As the interest rate is low, they might find there is no risk, which is a very worrying thing.

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