Why markets are heading north when economy is headed south

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Indian benchmarks equity indices opened higher on June 1 with Nifty hitting a fresh all time high above 15,600 and Sensex above 52,000-mark. The record run in stock markets in the last few trading sessions has taken many by surprise especially as it comes amid the severe second wave of Covid-19, extended lockdowns in about 19 states, crude oil prices at over $70 per barrel, continued domestic fuel price hikes, economic disruptions and rising fiscal deficit numbers.

Weak macro picture Fiscal deficit for 2020-21 was at 9.3% of the gross domestic product (GDP).

On the one hand, we saw India’s Gross Domestic Product (GDP) contract by 7.3% in 2020-21, as per the provisional data released by the government last evening. This is the biggest dip Indian economy has seen since independence in 1947, the sharpest contraction seen in last 40 years on the back of the Covid-19 pandemic.

On the other hand, just last week, we saw BSE listed firms achieve the $3 trillion market capitalisation for the first time ever.

Is the stock market disconnected from the economy? Looking at the weak macro data points, one clearly sees a stark contrast in stock market performance to the real economic growth. So, what is leading stock markets to clock in record levels?

Markets seem to be shrugging off all uncertainties for the moment and taking a leap of faith. There is an underlying belief on the strong economic recovery from the pandemic on the back of the increasing pace of vaccinations and the falling Covid cases. India reported on Tuesday its lowest daily rise in new coronavirus infections since 8 April at 127,510 cases over the past 24 hours, while deaths rose by 2,795.

Strong results posted by major companies in Q4FY21 has helped investors look beyond the distressing Covid-19 crisis. Confident commentaries by corporates on expectations of business profitability growing in the coming quarters has helped markets inch higher.

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Apart from this, positive global cues also have a part to play. Rising global demand outlook, rise in commodity prices and availability of liquidity are fueling the current rally.

As for the GDP numbers, economists believe markets cheered the better than expected data as Q4FY21 real GVA grew 3.7% (YoY), much higher than the market consensus. Indian economy contracted 7.3% in FY21 against a 4% expansion in FY20. However, experts pointed that Q4 GDP growth of 1.6% showed that the recovery had gathered strength with unlocking of the economy.

BSE chief Ashish Chauhan had earlier spoken to Money9 and shared insights on this saying, “Markets tend to lead the economy as it is forward looking. On the other hand, the economic data is backward looking, it reflects the past performance and comes with a lag”.

Are markets in a bubble? The RBI recently warned about a possible stock market bubble in its annual report for FY21.

In the context of financial or economic markets, a bubble generally refers to a situation where the price of a stock, financial asset, an asset class or an entire sector exceeds the fundamental value by a significant margin.

“The widening gap between stretched asset prices relative to prospects for recovery in real economic activity, however, emerged as a global policy concern,” RBI added

Experts do say that while valuations are expensive, the scenario is same throughout the world. Experts also see future financial market movements to be guided by the progress made in containing the pandemic, the pace of recovery of global and domestic economies, and developments in global liquidity and financial conditions.

On top of that market veterans like Raamdeo Agarwal have given long term targets of Sensex at 2,00,000 giving hopes to investors for the continued run in markets on the upside.

Market outlook Dr. V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services said, “FIIs have been caught on the wrong foot. Their sustained selling from early April to mid May has proved to be a wrong strategy and, therefore, now they are making amends through heavy purchases. Massive FII buying of Rs 2,412 crores in the cash market yesterday is an indication of the likely direction of this market. The fact that India VIX is at a 52- week low also indicates the resilience of the market.”