The investor community was left puzzled when the US stocks hit a
record high earlier in August. At the height of the Covid-19 pandemic when much
of the global workforce was forced to stay home, the rise and rise of stock
prices made little sense. While some argued that the massive stimulus package
by the US government and the emergency rate cuts by the Federal Reserve had
pumped the stocks higher, others inferred it as yet another instance of a deep
dichotomy between the real economy and the equity markets seen over the past
few years.
The 2020 equity market record run amidst a flagging economy is by
far the widest gap between Wall Street and the main street. A similar trend was
seen in 2019 when the Indian economy was battling one of its worst slowdowns in
decades but markets kept hitting record levels.
Economists of the likes of former Chief Economic Adviser Arvind
Subramanian said that the fact that markets are buoyant while the economy is
sinking was a “puzzle”.
Major Indian stock indices
have also reclaimed the pre-March levels when the initial impact of the
Covid-19 outbreak began to
show up. This comes at a time when the economy logged its worst quarter on
record. The GDP growth rate fell by an unprecedented 23.9 per cent during the
April-June quarter (YoY). Other vitals of the economy also remained under
pressure owing to the lockdown enforced by the Union government in order to
break the chain of the virus transmission.
A majority of market pundits
will concur that financial markets do not reflect the real economy. They rarely
have. This is because the markets essentially are forward-looking. It is more a
gauge of how the investors expect the economy to perform in the medium to long
term.
Investors, for instance, are
betting the US technology companies and pharmaceutical companies to perform
well during the pandemic.
Source: Wall Street Journal
The tech stocks have had a
record run during the pandemic. The price-to-earnings ratio, at one point, rose
close to levels last seen during the dot-com bubble which means that investors
are willing to pay up to 75 times the current value of the stocks. The
expectations may or may not get the backing of earnings later on but the
expectations drove the stocks higher.
Foreign fund inflow in Indian equities improved significantly
since the month of June this year. While the economy was nearly at a
stand-still, institutional investors continue to bet on the economic recovery.
In essence, smart money chased investments when things were down so that
strategic investors could position themselves very well when the economy picks
up.
Similarly, the Indian equity indices had logged all-time highs
last fiscal in midst of a crippling slowdown because of the large inflow of
foreign funds. FIIs have played a major role in the movement of Indian markets
ever since significant inflow started to enter post liberalization of the
economy.
Response from Governments and Central Banks
The pull-back seen in the stock markets is largely because of the
unprecedented response of the central banks and aid-packages by the government.
The size of the economic package in the US, and the EU including developing
countries has been even larger than the one during the 2008 financial crisis. Central
banks across the globe have gone on a rate-cutting spree, which boosted the
liquidity levels in record time. Thanks to the liquidity support, the 2020 US
bear market was the shortest ever. Therefore it may not be wrong to say that
the investors are expecting a V-shaped recovery considering the strong and
quick response this time around.
A major part of this recovery rally has been caused due to the
influx of liquidity in the economy. This liquidity is not backed by earning
potential. It is possible that equities may reverse the trend if the earnings
don’t follow and match the liquidity infused. Besides positive news with
regards to a vaccine has also boosted equities. It is a matter of “when” not
“if”. The impact that the vaccine will
have in future can be judged by the recent sell-off following the news that the
trials of one prominent vaccine candidate were halted after some complications
developed in one of the participants. Markets bounced back when the trials
resumed.
Conclusion:
Pinpointing the exact reason for the growing disconnect between the stocks markets and the economy is difficult but the record run by global markets during the ongoing pandemic is certainly backed by strong liquidity infusion by global central banks. During these uncertain times, you may wish to rely on professional wealth managers. Tata Capital offers an unmatched bouquet of well-researched wealth management products for each asset class. The goal of experienced wealth managers at Tata Capital is to ensure that customers get the right solutions best suited for their investment goals.
09 October 2020
5 mins read
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