There is a method in the madness
Ram Suresh
Stock markets by nature are the antithesis of quintessence. Most of the time, their movements bely conventional logic and borders on the loony. Purists call the bourses a gambling den, questioning the wisdom of participants. Yet, for all the idiosyncrasies associated with a stock market, it is considered a barometer of a nation’s economic health.
This pretty much explains, in a nutshell, the character of stock markets. They are unpredictable and can take-off at a tangent, defying gravitational laws. Over time, however, like the saying the proof of the pudding is in eating, the resilience of markets score. One key reason for this behaviour is because money managers usually focus on the longer-term outlook rather than immediate issues.
The bullish stocks rally in India illustrates this point vividly. The market capitalisation exceeds the country’s gross domestic product (GDP), triggering questions about the sustainability of the rise at a time of slower-than-expected economic growth and lingering concerns a third wave of the deadly coronavirus is in the offing.
In late May, the total value of the Indian stock market climbed above $3 trillion for the first time ever, and has stayed buoyant through this month with benchmark indices hitting record highs. In comparison, the GDP is estimated at around $2.6 trillion in the year ended March 31, 2021. In other words, the market capitalisation stood at more than 100 per cent of GDP.
According to conventional wisdom, a market cap to GDP ratio of 50-75 per cent is said to be modestly undervalued, 75-90 per cent is fair valued, and modestly overvalued if the range is 90-115 per cent. Billionaire U.S. investor Warren Buffett is fond of this ratio, and once noted it was “probably the best single measure of where valuations stand at any given moment”.
By that reckoning, Indian stocks are in overbought territory and susceptible to a pullback. Other factors too support this theory. The pandemic has already taken a heavy toll, and there is a strong likelihood of more pain in terms of both human suffering and economic activity. Given these downcast underlying factors, the bullishness could qualify for the phrase “irrational exuberance” that was first coined by U.S. Federal Reserve Chairman Alan Greenspan to describe the dotcom bubble in the 1990s.
Seasoned market pundits, however, see a silver lining in the gloom. “The smarter answer may be that markets are discounting short-term pains of Covid for long-term gain of higher corporate profits,” Nilesh Shah, managing director of Kotak Mahindra Asset Management, wrote in a recent article in the Times of India.
He is likely to prove right. Fund managers have a better feel of the market pulse, and make their calls on future earnings of companies. Shrugging off the ill effects of lockdowns in the first half of 2020-21, many listed companies reported better-than-expected profits in the final two quarters, a trend that is bound to persist as large conglomerates grab more market share from the stricken medium and smaller firms.
More importantly, top companies have substantially reduced their debt, saving interest costs and putting them on course to reap greater benefits when the economy kicks into full throttle. Tata Steel Ltd cut its debt by about $4 billion in the year ended March 31, 2021, surpassing its deleveraging target of $1 billion.
“As a result,” Chairman N. Chandrasekaran noted in his statement to shareholders, “net debt-to-EBITDA (earnings before interest, tax, depreciation and amortisation) ratio has dropped to a healthy 2.4 in FY2020-21, from 5.8 in FY2019-20 and 3.2 in FY2018-19.”
Energy-to-telecoms conglomerate Reliance Industries Ltd has achieved a net debt free balance sheet ahead of time after a record capital raising exercise. During the past financial year, it prepaid $7.8 billion of long-term foreign currency debt.
Such developments are not easily discernible to the public at large, especially with politics, Covid-related happenings and gloomy economic news garnering a lion’s share of the visual and print media. No one can predict with certainty where stocks would be a year from now. It is equally foolhardy to dismiss the record-setting rise as the handiwork of speculators.
Suffice to say the stocks rally has legs. This is no bull in a China shop.
