Is There a Bubble in the Stock Market?

Reading Time: 4 minutes

RBI feels that the economic outlook is not good as per the current pandemic condition however the prices of the stocks in the market are going up. Therefore, it feels there is a bubble in the stock market.

Introduction

As per the RBI economy going bad due to COVID 2.0 but still, markets are touching new highs which is in the same range as last time highs.

There is confusion as the economy is sluggish or might come down and markets are going up. What could be the reason for the market going upside?

RBI says that there is a bubble in the stock market. Let’s check out few reasons listed by the Reserve Bank of India

Possible Reasons Listed by RBI

i) Money Supply

  • It is saying the quantitative easing that has happened all over the world is inflating the market.
  • The objective behind the money supply is under stress situation of the economy where there are no loan givers and hence that is the reason why the liquidity is improved into the market by RBI or Central Bank of India.
  • This step by Central Bank augurs credit growth in the economy with the common mentality that People should take loans and demands & activities should come on the track of normalcy. And, hence money supply happens.
  • As a result, this extra money supply can inflate the stock prices, or else it will increase inflation.
  • If we see how the stock prices have increased but inflation is still under control. Even though the Wholesale Price Index has gone up by 10%. But last year same month’s base effect was down, that’s why the numbers are up.
  • While, in the case of CPI Inflation, which is looked after by RBI is still under control and comfortable range i.e., 4%-6%, here RBI is not finding any problem.
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ii) Economic Outlook

  • All the Quarters of FY21 from Q1 to Q4 were showing a signal of improvement, which is a positive sign.
  • But, the problem happened in the Q1FY22 which is not improving but witnessed a scary situation. Hence,  RBI feels the economic outlook is not good but still the prices of the market are going up. Therefore, RBI feels there is a bubble in the market.

iii) Foreign Portfolio Investors (FPI) Inflows

  • FPI inflows were quite high in the last financial year where the economy witnessed multi-level high inflows. This could be also one of the reasons why the markets are trading at such a high level.
  • RBI feels that the market is not giving importance to one of the indications that are Economic outlook but only giving importance to the other 2 parameters that are FPI and Money Supply. That is not a good sign.
  • RBI feels the increase in stock price from the Year 2016 to 2020 is due to falling interest rates.
  • There are 2 benefits of falling interest rates.
    • Falling interest rates mean loan interest rates are also low. If the interest rate is low then interest cost and finance costs will also come down. If finance cost comes down then operating profits will increase. When operating profit increases the net profit also increases. Ultimately it will lead to a rise in earnings of the company. That’s a positive sign.
    • In Falling Interest Rate Scenario, Fixed-income securities investors will start finding other options for investments as they are getting less interest rates on their securities. They might find other options which will have equity as well. That could be one of the reasons that could take the market up. Falling interest rates and equity risk premium which are having increases attractiveness that could be one of the reasons why the stock prices are going up that’s what the RBI feels.
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View of RBI Against Bubble in the Stock Market

  • RBI feels the current situation is not sustainable. If we see long-term dividend yields it has come down. That not a positive indicator and price to earnings ratio (PE Ratio) is also highly inflated. Nifty’s PE ratio has down due to consolidated EPS has come down. Before that PE ratio was above 40.
  • All-time highs of Nifty PE ratios which could not sustain which was 28. Now it has gone up 40% to 50% still the market is not correcting. Hence, RBI feels it is not going to sustain itself.

EPS growth for the companies from the last 4 years was quite muted, that’s what the market is feeling.

If the sluggishness is compensated by the market with earnings growth then there could be a rational valuation that makes the market comfortable with the forward PE ratio.

So RBI has given a very important statement “Liquidity support cannot be expected to be unrestrained and indefinite and may require calibrated and unwinding once the pandemic wave flattened and the Real economy is firmly on a recovery path ”.

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Conclusion

As per RBI, the Money Supply and FPI Inflows are the 2 major factors that are currently uplifting the market, and the market may witness some consequences, once these factors die down.

If we see it from the traditional thought process then there is a feeling of the bubble. But markets are quite forward-looking and for the same reason, the market will not correct twice.

Only time correction should happen price correction in the market looks difficult. At this point, the Investor should invest in SIP formate and should not invest in a lumpsum manner, and should consult the financial advisor before investing.

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