Stock Market v/s Economy – Why such a distorted relationship?

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Stock Market v/s Economy – Why such a distorted relationship?

We have always learnt that the stock market is the barometer of the economy. However, over the past several quarters, this has not been the case due to their distorted relationship. The Indian economy has been in a downturn over the past several quarters because of slowdown witnessed across sectors. India’s consumption story, which has been the growth engine for India’s economy has somewhat lost its steam for several reasons. Firstly, the economy is yet to recover fully from structural reforms taken in the past like Demonetization and GST. In the more recent times, limited increase in minimum support prices (MSP) and liquidity crisis amongst NBFCs has led to slowdown in the economy. Further, rising trade protectionism and global slowdown have led to lower growth in the exports segment.

In fact, the latest GDP growth touched a six-year low at 4.5% for Q2FY20. However, despite such weak economic data, the stock market continues to trade at record highs.

Why is that?

Let’s break it into four different but crucial factors that have resulted in such contrasting direction of the economy and stock market.

Global markets

As much as we are living in a world of rising protectionism, the global markets still remain highly synchronized. However, the degree of outperformance or underperformance depends on how the economy is performing. Coming to global growth, yes the global economic growth has slowed from its peak. However, it is yet not a cause of alarm for any of the major economies. Therefore, the concern of global economic slowdown is largely overplayed as it’s made from sharp fall in yields and sharp surge in gold prices.

Further, the central banks across the world acknowledge the fact of slowdown and are doing enough to support growth. India, on the other hand, faces structural issues in its economy that are largely domestic in nature. And that is the reason in 2019 itself wherein global markets have seen a decent rally, India has been a sheer underperformer as compared to developed economies as well amongst BRICS nations.

Domestic flows continue to remain resilient

Over the last 3-4 years, there has been a sharp jump in the number of retail investors due to higher financial literacy, increased government’s focus on financial inclusion and lower interest rates. Despite such tumultuous times in the market over the last two years, retail investors have kept their faith in India’s growth story and continued to stay invested. The monthly SIP flows in India are nearly Rs. 8,000 cr and overall equity inflows in 2019 have been nearly Rs. 70,000 cr. This has reduced our dependence on foreign flows, as despite FII selling, the markets remained resilient. In recent times, we have seen renewed buying from the FIIs which has supported the markets.

Measures continue from Government and RBI

Both the government and RBI have acknowledged the slowdown and have taken several steps to revive the economy. The RBI has shifted its focus to growth and has cumulatively cut repo rates by 135bps and has also announced measures to ensure adequate liquidity in the system. The government too has taken several steps with the biggest one being the corporate tax cut. Further, there are several measures announced to revive key sectors like Auto and Real Estate, which has been under tremendous stress. Obviously the above-announced measures would take a few quarters to yield results however: markets are pricing in recovery and are expecting more reforms by the government to promote growth.

Rally confined only to select stocks

This fact is known to everyone associated with Indian markets that in the last two years the markets are up only because of few outperforming large caps. On the flip side, the broader market continues to struggle with growth and other company-specific issues (corporate governance, liquidity, etc.). This behaviour is new to Indian markets but is right as if the other three factors mentioned above are supportive; it’s very difficult for the markets to fall. Consider this, if you are a fund manager and a group of investors hands you Rs. 8,000 cr every month (total monthly SIP book in India) to invest into equities. In such a situation, the fund manager is bound to select stocks that have high growth or are safer bets.

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