Let’s Find Out the Reason Behind The Rising Stock Market

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Equity markets worldwide have regained their footing led by a strong rebound in the US markets. US markets have practically led the charge to recovery as key indices like the S&P 500 and Nasdaq have already touched lifetime highs. Even Indian markets are not far behind as they are only 7% from its all-time highs.

So, the important question is – what’s the reason behind the rising stock market?

Give us 5 minutes of your time for this article and we promise, you won’t be disappointed.

To answer this, let’s first look at global reasons.

Let’s recap a bit, when the pandemic started across the globe it shook the entire system as countries announced lockdown, uncertainty increased multifold as the duration of lockdown and fatality of the virus was not determined, and most importantly the economic impact of the virus was expected to be huge due to practical shutdown of the economy. All these things led to carnage in global indices in March.

However, clarity started to emerge as infections started to peak in many economies leading to easing of lockdown restrictions and restarting the economy. Meanwhile, the governments and central banks across the globe took charge and announced an unprecedented fiscal response to reduce the economic impact of COVID – 19 supporting businesses and individuals.

Well, if we may quote the IMF, the fiscal response is, in fact, greater than the Global Financial Crisis. These measures led to an influx of liquidity into the system and all it needed was a glimpse of demand recovery to find its way into risky asset class like equity. And it happened, as easing restrictions led to reopening of the economy and high-frequency indicators pointed towards growth bottoming out.

This is not it, as governments across most developed markets are preparing for stimulus package 2.0 to revive economic growth. Further, despite the recent spike in inflation across economies, the central banks are hell-bent on growth revival.

The recent statement by the US Fed that they would ‘tolerate’ higher inflation corroborates that central banks would focus on growth. So overall, the reopening of the economy, early signs of recovery, and hopes of additional package coupled with liquidity provided by central banks have aided the rally in global equities.

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This is for global equities, then why have Indian markets gone up significantly?

Well, as much as we say that markets should move with its fundamentals, the truth is that global equity markets are closely linked.

If we recall, the Indian markets bottomed in late March (around 23rd) and that’s when the lockdown had just started in India. However, equity markets are always forward-looking and investors had sensed that it will not be as bad as it was anticipated in the sharp decline in March.

It was not just global recovery that aided the rally; Indian markets had its own fair share of reasons for delivering the performance it has over the last 4 months. What are the reasons? Let’s delve into it.

Unlocking – The first step

The first reason definitely is the unlocking of the economy which has helped businesses to restart and somewhat return to normalcy. Even though the cases are rising, it has become increasingly clear that the government is bent more towards re-opening as suggested by the actions in the past, and the trend is widely expected to continue going forward as well.

And the Demand returns!

The unlocking was definitely the first step towards normalcy however the important thing was that demand should return, as unlocking alone would not help, right? Well, as it turned out the rural economy (which has been the key growth driver especially in terms of consumption) was one of the least affected due to the pandemic as evidenced by resilient demand for FMCG, Farm equipment, and Agri products.

Further, the commentary from the management of most of these companies and many others (in consumption space) has been quite encouraging. Not only this but rural economy (which still largely depends on agriculture) growth momentum is expected to continue due to normal monsoons (6% above average) and better sowing activity.

This has come as a big relief for the government (even investors) as they don’t have to shell out more freebies and can concentrate on affected sectors and fiscal prudence.

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Government trying hard to keep fiscal deficit in check

The government fiscal situation has turned from bad to worse due to the pandemic as on one hand the tax collections have fallen meaningfully and more spending is required to revive the economy.

But the government’s approach has been quite commendable with a fiscal package (Rs. 20 trillion) mostly focusing on making India ‘Atma Nirbhar’ through loans, liquidity, and credit guarantee. Because letting fiscal deficit slip by announcing a large stimulus package would risk higher inflation.

Further, with the recent run-up in the markets, the environment now is far more conducive for the government to raise capital. Therefore, recently, there has been a lot of traction from the government towards privatizing and disinvestment to keep the fiscal balance in check which is a prudent approach for long term stability.

This instills confidence in investors that the fundamentals of the economy are intact.

COVID-19 – A boon for consolidation

We had tweeted recently about what COVID-19 has done for the economy which even demonetization and GST could not, which is to make the Indian economy more organized, why?

Large companies have capabilities to withstand this crisis due to their balance sheet strength and moreover, they have a well-established distribution network to reach products to consumers.

So, the expectation of faster consolidation in many industries has led to the re-rating of many large prominent names. This is not it, the increased thrust of government recently towards Make in India 2.0 taking advantage of the anti-China sentiment is also expected to reduce imports (good for the economy), promote domestic businesses and manufacturing.

This has further led to re-rating in certain defense and consumer electronics stocks.

And lastly, were earnings that bad?

No, in fact, if we compare to market expectations, the earnings were much better than expected. Firstly, sectors like FMCG, IT, Telecom, Pharma remained the least affected and therefore reported a good set of numbers.

The consumption stocks (cement, auto, consumer durables, and paints) were expected to report dismal numbers as they were impacted by the lockdown.

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But, companies were pro-active in getting their costs lower to reduce the impact of lower operating leverage, and plus lower commodity prices helped as well. Therefore, profits turned out to be better than expected.

Commodity sectors (Metal, Oil &Gas) were also expected to report subdued numbers due to a sharp fall in commodity prices but these sectors normally don’t react materially to earnings that much as they do to global commodity prices.

Lastly, the heavyweight Banking & Financials reported decent numbers but still, investors were varied as Bank Nifty is still ~30% off its highs whereas Nifty is hardly 7% away.

This is because of the concerns regarding the potential sharp rise in NPAs after the moratorium ends. Therefore, if we look at pure Nifty 50 companies, the earnings were definitely much better than what the street was estimating.

Some might argue that the headline index (Nifty and Sensex) is not giving a true picture of the economy, but was it even giving before the pandemic?

No, remember the markets were trading near lifetime highs when economic growth was consistently declining over the past several quarters before the pandemic.

The underlying principle then was that large companies would benefit at the hands of smaller companies (market share gains) and the economy was on track to getting more organized.

Well, these shifts are expected to accelerate further after the COVID-19 pandemic. This would lead to large companies becoming bigger and consequently concentration of earnings, a trend which is also observed in the US.

So, while the economy may or may not revive as anticipated, the wider expectation now is that prominent companies (large caps) would continue to grow much faster than their respective industry.

To sum it up, yes global liquidity has been one of the driving forces, but these reasons are also important pillars to the current market rally.

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Monergise
Monergise helps you stay updated with the current trends and make better investment decisions. All the articles are written by a group of finance professionals having experience of more than 10 years in Indian markets.
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