On the 23rd of March, 2020 the first ever national lockdown was announced in order to curb the spread of Coronavirus, and on the same day both Sensex and Nifty experienced massive falls of 13.15% and 12.98% respectively. Post that they have shown strong bullish trends and over the course of the last 15 months the Indian Financial Markets have been booming, hitting all time high records. The benchmark index Sensex has seen a one fold rise i.e. nearly doubling with 100% growth from the slump recorded on 23rd March, 2020. Is this a momentous event to celebrate or something we should look out for and be more cautious?
The huge amounts of Capital Inflow into these markets has risen due to major FDI and a lot more Retail Investors actively participating. During the ongoing Covid Pandemic the amount of FDI equity inflow has grown exponentially, making India a hot spot for global investors. FDI policy reforms, and relaxation of rules to run a business have definitely made Global Investors believe that there is huge potential in the Indian Financial markets. As per the Ministry of Commerce the Indian economy has received the highest amount of FDI inflow of $81.72 billion during the financial year 2020-21, which is also 10% higher than the amount of FDI inflow in the previous financial year of 2019-20. Specifically the FDI inflow in the equity markets has grown by 19% in FY 20-21 standing at an excessively large amount of $59.64 billion. The reports also reveal that Singapore, USA, Mauritius and UAE have been the largest contributors to the FDI inflow.
Yet another major source of inflow comes from small retail investors within the economy. The number of DEMAT accounts opened during the COVID pandemic stood at a whopping high level of nearly 1.45 Crores for the year 2020-21. As per an SBI Report there are 142 lakh new investors who have entered this lucrative market in 2020-21. One reason that has led to such a massive participation is the lockdown owing to which many businesses have been temporarily shut, and all the surplus fund which was being used to run such businesses is now flowing into the stock markets. Yet another potential reason could be the reallocation of bank savings due to falling interest rates.
The indicators on which these market participants base their decisions matters a lot. It was found that stocks which have seen a very large retail participation suffered from weak fundamentals and lacked good business opportunities. And this is surely a cause of concern, as many stocks are being overvalued and someday sooner or later will be revised to their fundamental intrinsic value. This revision can have a devastating effect
on the pockets of such retail investors. The Annual Report published by RBI for FY20-21 highlighted that the Price to Earnings ratio of the benchmark Sensex is way higher than its long term average indicating the overvalued nature of the same. The same ratio for Nifty 50 also recorded its all-time high during the pandemic standing at 42 compared to its long term average of 22. This puts light on the fact that investors today are expecting insanely large and unrealistic growth returns.
As the current situations reveal, there is a financial bubble forming slowly and steadily in the Indian Equity Markets. The existence of this economic bubble becomes clearly evident due to a few reasons. Firstly the Stock Markets have been rallying in spite of very poor economic forecasts and low GDP growth rates. According to a report published by the Govt. of India the GDP growth has fallen by 7.3% in the financial year 2020-21. Second is the massive rise and spike in the number of Retail Investors, this certainly makes the markets relatively less efficient as most (but not all) of the small individual investors do not follow fundamental Finance rules and principles, leading them to base their decisions on incorrect interpretation of various parameters which in turn will lead to poor investments. Another potential reason is the massive relaxations in monetary policy and increase in money supply which has partly led to such asset price inflation. All of these things put together can lead to unbelievably high skyrocketing prices and an Illusion of prosperous investments.
So now that we know that there is a Bubble, what needs to be done? As per Finance theory and experience the most basic but reliable technique is to base investments of Financial rationales and do not follow the crowd. Before investing in any stock do you fair share of research regarding its business opportunities and long term prospects. Take calculative and well planned risk, this will definitely lead you to picking better investments matching your risk appetite. Set realistic expectations, do not be the part of the herd and avoid the greed to make free money.
The bubble’s catastrophic impact is felt when it bursts, i.e. the stocks are revalued at the right level. One definitely needs to watch out for this, in case we become victims of the burst this can lead to a huge chunk of our investment and wealth being eroded in no time. From my point of view, the bubble continues to inflate and the markets will surely rally for some time. But once the COVID pandemic comes to an end and we completely move to the pre pandemic way of operations, the bubble will burst. Few reasons for this to happen is the potential withdrawal of retail investor funds which will then be channelized into their own businesses, tighter monetary policies and the lack of opportunities by overvalued companies who have witnessed a sharp price rise. In my opinion there will be a sharp correction of nearly 10% to 15% in the next 3-4 years which will come with fatal and harsh consequences for market players. Hence the fact that our Equity market is booming is surely not a reason to rejoice!
Author: Kushboo Luniya
B.Sc. Economics & Finance, University Of London