While stock prices are believed to be largely a factor of real earnings, recent trends in the Indian stock market have been in contradiction.
Economic Survey has come up with an explanation for this, but this is filled with flawed assumptions and conclusions.
What is happening in the Indian stock market?
Despite the faltering growth story over the past four years, the Indian stocks markets have been in high spirits.
The BSE Sensex has vaulted by over 70% in this period despite just a 14% absolute expansion in its constituent companies’ earnings.
Multiple agencies have tried to reason with the high valuation of Indian stocks and the Economic survey has also come up with an interesting explanation.
What is the “Economic Survey’s” explanation?
The US Comparison - Sensex and the US S&P 500 have shown identical gains in 2 years, with about 26 convergent trends, despite the underlying economies being quite dissimilar.
Notably, Indian stock market surge has coincided with a decelerating economy, falling corporate profits-to-GDP ratio (3.5%) and high interest rates.
US markets have been backed by an improving economy, stable corporate profits-to-GDP ratio (9%) and negative interest rates.
While the Survey is hinting that the US market gains thus have far better fundamental moorings than India, it doesn’t persist with it.
The Hypothesis - While warning of a “sudden stall” in global asset prices, the Survey stops short of extending this dire warning to Indian markets.
Instead, it surprisingly speculates that the higher valuation may represent a “new normal” where investors have shrunk their demanded for equity capital.
As a fivefold expansion in mutual fund inflows were seen in FY17, it argues that there has been a structural shift in investments.
This, it reasons, is due to anti-black money campaign of the government, which has nudged investors away from gold and property.
What are the flaws?
The world over, retail investors chase high returns and the Indian investors have been upping their equity bets due to double-digit market gains.
The tax-free status for equity returns, on top of plummeting debt returns, may have driven this investing behaviour rather than any government campaign.
Notably, there is a call for a policy-level rethink on the exceptional tax breaks on equities, which may be necessary to quell the euphoria.
Notably, “foreign portfolio investors” still control over 25% of stocks.
Hence, the survey’s assumption that the new domestic enthusiasm will offset global tightening doesn’t stand merit.
Therefore, apart from waiting anxiously for the resurgence in corporate earnings, Indian markets needs to pay close heed to global trends.
