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The shutdown has one anomaly in the economic space and that is the stock market. The tendency to move up since March has been remarkable, which has often raised the question of why it is so? Is it pure irrational expectations and greed, the push being given by stock experts in the media, which is driving investment? Or, is there reason in this madness?

There are two things about the stock market that have to be understood. The first is that over the longer time frame it is supposed to reflect expectations of earnings. Hence, if companies are expected to do well based on future earnings, then prices reflect this sentiment. This is distinct from the first quarter earnings of almost all companies, which generally are quite bad.

The second is that markets react to events on a daily basis but then move on. Hence, a disappointment in the outcome of the government package will shake the market for a day or two, but subsequently stocks will be driven by other factors. If this is accepted, then it becomes easier to see some method in the stock movements.

The Chart traces the movement of the Sensex starting January 1 and, quite interestingly, the trough was reached on March 23 with a fall of almost 4,000 points even before the shutdown was announced. The descent had started from the second week of March as fears of Covid, the episodes of which were more in China and Italy, seemed to be coming gradually onshore. The movement subsequently is quite distinct as there has been a general upward move with regular waves of stable amplitudes.

Quite clearly, the announcements made by the government on the lockdown periodically helped in changing the mood in the market. The shape taken by the Sensex is in the nature of an extended ‘V” shape recovery, where a sharp decline was followed by an extended and stretched recovery.


The Table lists some important elements associated with stock movements, and represented by the Sensex. The index has been averaged for the month to avoid the end-points extremes, which can distort the picture given that the environment was volatile with every announcement relating to the shutdown having a single session impact on the stocks.

FPIs, MF investments

The immediate factors which come to mind are the FPI (foreign portfolio investment) inflows and mutual funds’ net investments in equities. A contemporary measure of fundamentals, the PMIs, have been drawn in as these are leading indicators that are compared over the previous month and can be related to changes in stock indices.


One factor that has affected the Sensex is the introduction of the lockdown, which started off being ‘complete’ in April but then got diluted in stages at different levels, raising the hope that things could become all right on the economy front. However, there has been dithering at the state level, which has meant there are no signs of normalcy anywhere in the country.

The Table reveals that there seems to be some economic rationale for the Sensex movements once it is accepted that it is influenced by contemporary developments in the short run. January had strong FPI supported by good confidence levels going by the PMI. February was an aberration when there was a decline even while mutual funds invested heavily, and the PMIs were satisfactory if not good.

The threat of a world recession and the slow spread of Covid at that time did raise serious concerns. March was a washout as FPIs moved out in large numbers as confidence levels declined, with services slipping into the negative territory. Mutual funds were strong as year-end investments from households in equity schemes increased. But this could not reverse the tide.

April was the first month of the lockdown and the disastrous effects could be felt in all the four variables, with the PMIs going to their lowest levels. This was probably why the confidence level came down sharply. May witnessed a slight recovery as the government opened the doors, albeit gradually.

Though in the negative zone, both the PMIs showed improvement and inflows into equities were positive. June saw a continuation of the mood, while mutual funds were marginally negative, FPIs were bullish and the negative sentiment in the manufacturing and services sectors improved.

In line with trend

Hence, seen in this way, the Sensex movements are explainable even in the short term. The present level of 36,000 is broadly in line with what it was just before the sharp decline took place at the beginning of March. If this is so, one may expect further upward movements in case the government hastens the ‘unlock’ programme; currently, the government is vacillating given the high incidence of the epidemic.

The clinching factor would be the flow of funds as the PMI indices would tend to move upwards though that of services will remain downbeat for an extended period given that it would take more conviction to really open up this sector.

The stock market has, in fact, followed fundamentals during this period of a little over six months. The relation with negative growth in GDP or negative growth in corporate sales and profits does not hold. Yet, this cannot be used as an explanation to relegate the stock movements to unbridled speculation as there is reason in this apparent madness.

The writer is Chief Economist,

CARE Ratings. Views are personal




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