Editorial

The recent stock price rally is fuelled by liquidity, has no fundamental basis

| Updated on June 09, 2020 Published on June 09, 2020

The primary mover of the stock prices at this juncture is demand from foreign portfolio investors. After pulling out close to ₹62,000 crore in March, they turned net buyers after mid-April

The disconnect between the economic conditions and the stock price movement has never been as stark as seen in the last two months. India, along with other global economies, is in the throes of a pandemic that has not only taken a toll on human lives but has also brought growth to a near halt over the last two months. Yet, Indian benchmark index Nifty 50 has managed to gain over 30 per cent since the low recorded towards the end of March this year, in line with its global peers. This rally has surprised everyone, because the global economy is currently facing the worst recession since the Great Depression, according to the IMF. Most research houses project the Indian economy to contract between 3-5 per cent in FY21. The commentary from Indian companies is also quite dismal. While the earnings in the March 2020 quarter were impacted only mildly, June quarter earnings are expected to be abysmal due to supply chain disruptions, absence of demand, lack of labour and tight liquidity.

Given this flood of negative news, the cheeriness exhibited by the stock market may strike a very discordant note. But it needs to be understood that stock price movements are a slave to market forces of demand and supply. The primary mover of stock prices at this juncture is demand from foreign portfolio investors. After pulling out close to ₹62,000 crore in March, they turned net buyers after mid-April. It is apparent that some of the money being pumped by the global central banks to help their economies survive the pandemic, is beginning to find its way into all emerging markets, in the form of foreign portfolio investments. Empirical data suggests a strong link between the US Federal Reserve’s quantitative easing programmes and FPI flows in the period between 2009 and 2020. Besides liquidity, many value investors may also have found the stock prices quite attractive after the crash in March, helping the revival. The trailing 12-month price earning ratio of the Sensex had declined from 28 times in December 2019 to around 18 times towards the end of March. Lastly, stock prices are mostly led by future prospects rather than past performance. With the economy beginning to open after the lockdown, optimists may be hoping that the worst is behind and there could be smart recovery in the second half of FY21.

But given the fact that India is yet to contain the spread of the infection, and movement being restricted in the larger metros, the optimism among the stock market fraternity may be premature. The economy was already in a structural slowdown in FY20, taking a toll on corporate earnings. With consumption, the primary driver of the economy, taking a knock and the government constrained in making capital spends to revive demand due to tight fiscal situation, the uncertainty over earnings growth is likely to persist well into FY22. Investors would therefore be well advised to tread this treacherous phase cautiously.

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Published on June 09, 2020
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