There is a near bloodbath in the economy post the most severe health shock from COVID-19 outbreak and the business disruption from a 74-day lockdown. The Rs 200 lakh crore Indian economy is expected to shrink between 5 and 10 per cent in 2020-21 for the first time in four decades. The government's budget math has already gone for a toss because of falling tax revenues and additional expenditure that is required to fight coronavirus disruptions.
The first quarter ( April-June) for corporate India has washed away with near zero revenues.The unemployment rate is soaring at 24 per cent plus according to the Centre for Monitoring Indian Economy (CMIE). There are huge job losses in the unorganised sector, which are not reflected anywhere as there is no data.
But the country's stock market is defying all logic and the science of reasoning. In just a matter of 54 trading days, the barometer of the market, the Bombay Stock Exchange (BSE) Sensex has jumped by 32 per cent to 34,287 points. The market touched its lows just before the lockdown was announced in the last week of March this year.
In the same period, when the stock market was soaring, India's coronavirus cases jumped from 500 levels to a mind boggling 2.36 lakh. By next weekend, India will become the fourth largest country in terms of coronavirus cases only next to the US, Brazil and Russia. There are more worst case scenarios than the best case scenarios in the market.
So what explains the sudden buoyancy in the stock market when neither the economy nor coronavirus cases are bringing any comfort for the public, corporate India and the government?
The stock market today looks like an island separated from the economy or like a casino in a corner street. By the way, the stock markets were functioning smoothly in the last 74 days lockdown despite the first big pandemic hitting the country and a serious health crisis for the country.
The first explanation for stock market rise could be the way people look at Sensex or index of 30 blue chip companies as a barometer of the market. The 30 large companies are actually the creme de la creme of corporate India. The top-tier bank like HDFC Bank, the biggest mortgage lender HDFC Limited, the biggest private conglomerate Reliance Industries or names like Infosys, ITC and Bajaj Auto - the price movement in these companies is actually driving the Sensex up. These companies are anyway much better placed and also have a wherewithal to fight the COVID-19 impact with cash reserves and also their ability to raise resources from the market or banks if need be. The speculators are also betting on these companies in these times of gloom and doom.
Currently, the Sensex represents half the market capitalisation of the BSE listed companies. Therefore, the 30 stocks actually rule the entire market.
The second reason for buoyancy is probably the shrinkage of the universe of the good quality companies. In the last 5-6 years, corporate India was on a de-leveraging mode. The weakest players have fallen on the way side. Be it steel, power, infrastructure or NBFCs, there is a limited stock of good quality companies with good management in the market. There is a mad rush in the market for zero debt companies with high margins post coronavirus. The stocks of these companies are definitely on an upswing for valid reasons as they have the right things in place to bounce back. The markets always discount the future and smart investors are buying these companies for long-term returns. But the caveat is the valuations. These companies are already reaching the pre-coronavirus price to earning ratios, which is a cause of concern as the shrinkage of growth in the economy in 2020-21 and the subsequent recovery will take time.
The listed companies space is itself very limited with only 2,000 odd companies. There are over 11 lakh companies registered in India. For instance, MSMEs, the hardest hit, are not represented in the market. So the bloodbath in the MSME space is not reflected in the stock market. In fact, there is a BSE250 Small-cap index which is up by 36 per cent since March 24 , when it touched its 52 week low. Raymond, PVR, IDFC,Bombay Dyeing are some of the companies in the small index. The small cap index also in no way represents what is happening to small companies in India.
Over the years, the space for good quality listed companies is itself shrinking. The insolvency and bankruptcy code (IBC) has seen liquidation of hundreds of companies. Similarly, there is a change of management in many such companies. Some buyers have even delisted these companies from the stock market, while many defaulting companies are stuck in the bankruptcy process. The separation of wheat ( good companies) from the chaff ( bad companies) has also resulted in the stock market rewarding the remaining companies left in the market. The investors are also quickly switching from bad names as there are now more disclosure requirements. The listed companies are now required to inform the stock exchanges on any default in the loan obligation.
The surplus liquidity in the system is also playing a role in the stock market jump in two ways. First, the excess liquidity and low interest rates are helping well managed companies to get cheaper funds or replace their high cost debt with lower costs. Secondly, the surplus liquidity is also finding its way into the stock market through treasury operation and other means. In a declining interest rate scenario, the options for depositors or those investing in fixed income securities are also limited. A part of these savings are also getting diverted to stock markets for better returns.
The positive sentiments globally are also driving the market. The NASDAQ in the US is up 40 per cent from its lows of March, while European FTSE-100 has gained 30 per cent in the same period. The story is similar in those markets as select stocks and surplus liquidity are driving the market. Indian investors are also betting that a part of the global liquidity would flow to emerging markets for higher returns as interest rates and debt market returns are near zero in those markets.
Many suggest the stock market is all about 100 plus companies and 4 crore investors whereas the economy is a much bigger space. But investors should be watchful as valuations are getting stretched given the expected shrinkage in the economy. The lockdown is still in force and India's coronavirus cases are yet to peak. The exact damage to corporate revenues will be known only after the first quarter ( April-June). The first quarter is likely to be one of the worst for corporate India.
The investors should be watchful not to bet on stocks with crazy valuations. The herd mentality is already at play in the stock market with too much money chasing too few stocks. With two big critical spoilers - economy and coronavirus - thrown out of the window by investors, the stock market looks to be behaving like a casino.