The Stock Market Bubble

Imagine there is a company X. It has recently started and is doing quite well. The owner of that company wants to expand its business in those cities where he thinks the company would flourish. But, he doesn’t have that much money. His friend comes to his help in return of some portion of the profits the company will make. This becomes successful and both of them are content by making money. Something like this, on a bigger scale, happens in a stock market. A startup would present its ideas through advertisements and people interested in it buy its shares. This makes them partial owners of the company and all the profits and the losses are shared among them. If the company does well, more and more people would like to buy its shares. Hence, more demand will push up its prices. At this point of time, the existing shareholders can sell their shares to gain a profit. If there is a chance that company will not do well in the near future, the shareholders would want to sell their shares (or stakes) before its price fall down. So, stock market is all about how well you understand the factors that will affect a company’s performance. It is a complex task but, if done properly, one can make a fortune out of it.

All these trades of buying and selling stocks (or shares) are done at a Stock exchange. Two primary stock exchanges in India are Bombay Stock Exchange (BSE) in Mumbai, and National Stock Exchange (NSE) in Delhi. Sensex and Nifty are the indexes of BSE and NSE respectively. It tells us how majority of the companies listed under these stock exchanges have done in a particular day. Therefore, if one hears that Sensex has rallied 500 points today, it means that stock prices of most of the companies listed under BSE has increased. The methodology of taking out the points is a little complex so let’s not get into that. After you have understood the basic idea behind stock markets, let’s now get into the latest news. The Sensex crossed 50,000 points first time ever in its history of 145 years, on 21st January 2021.

Source – https://finance.yahoo.com/chart/%5EBSESN#eyJpbnRlcnZhbCI6ImRheSIsInBlcmlvZGljaXR5IjoxLCJ0aW1lVW5pdCI6bnVsbCwiY2FuZGxlV2lkdGgiOjQuNDE3MDA0MDQ4NTgyOTk2LCJm

The above graph shows us the performance of sensex in last one year. One can see a sudden downfall from March 2020. The most stringent lockdown in the world implemented by India was the cause of it. Clearly, at a time when everything stopped, the investors would have taken their money back before they could incur losses. Sensex picked up its pace from April and then it moved up, up, and up. There was no looking back. Reaching to an all time high just after eight months. The question then arises is whether our economy is doing this great. Are the investors so confident in India’s economic future? There is something fishy. There is no question that the pandemic has pushed our already hurt economy at least two years back. If we look at what measures government has taken, I can’t see anything other than the 20 lakh crore package which was mostly based on RBI’s liquidity and whose actual value was not even 2 lakh crore. The auto sector recovery was nothing but a piling up of inventory. The corporates made profits in the next half of the month, but it was by driving down their expenses like firing employees or cutting salaries or managing to decrease the cost of raw material, which brings down the purchasing power of the people and hurts the overall economy. And, India is looking at its first ever contraction in many decades. If these were not enough, the fact that stock market went up even after the contraction figures for the first quarter of 2020-21 (-24%) were out, is rather shocking. Then, what are the reasons that the market kept on rallying?

Source – RBI Monetry Policy Report, October 2020

The table above tells us that RBI printed more than 11 lakh crore from February 6 to September 2020, and the central bank continued to do so even after September. Not only RBI, but the Central banks all around the globe flushed money into the financial system in order to fight the pandemic. And all this money found its way into the stock markets including India’s. This was done by cutting the repo rates. Repo rate is the rate at which RBI lend to banks. Cutting it is the indication for the banks to cut their interest rates on loan. The logic behind it is, at the time of slowdown, lower interest rates will allow the corporate to borrow more and expand, the government whose tax collections have crashed can borrow cheaply as well, and of course, people can borrow more to spend more. This will keep the economy on track. But, it has resulted in the opposite way. Lower interest rates on loans and hence on deposits have let the depositors to look out for different options. At a time when inflation is 6-8% and the interest rate on deposits is 4-5%, the depositors are practically losing money. Hence, many of them have gone to the stock market looking for the better returns. This can be seen from the fact that millions of demat accounts (essential for stock tradings) have opened up in 2020. Now, let us look at the returns from Sensex:

Source – https://www.ceicdata.com/en/indicator/india/pe-ratio

The above graph shows the price to earnings ratio of Sensex in the last one year. The P/E ratio was 34 on January 2021. This means that for every 1 rupee that companies listed under BSE earned, people are willing to spend 34 rupees. This is exorbitantly higher price to earnings ratio even when compared with the dot com bubble or when market rallied in 2007-08.

To conclude, the stock market is absolutely disconnected from India’s economy and even the RBI including its Governor has said this many times now. But, the fact is RBI has also played a major role in it whether or not they admit. And if you are looking for higher returns, sorry but it is not quite possible in today’s time. The stock market bubble is growing and it will definitely burst. When? Don’t ask me.

 Bulbulon ko abhi intezaar karne do 

 -Vishal Bhardwaj, Usha Uthup,
         Rekha Bhardwaj in 7 khoon maaf 

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