Why markets are happy in these troubled times

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India today looks as if somebody stuck a pole into a beehive and shook the bees out of their daily routines. You don’t mess with bees’ routines for they get really angry! Indians today are angry over what they perceive are the acts of a “fascist” government, including raising hostel fees that have been stagnant for over 40 years and have no relation to the current levels of purchasing power. Others are angry at those who are angry. Yet others are letting off steam unrelated to the current issues but maybe just the stress in the extended family—why waste a good fight? Most others are generally feeling bad about the news of a slowing GDP, a consumption pull back and an overhang of bad news about the economy. One part of the country, however, seems to be immune to this anger and grief—the republic of the stock market is literally on its own trip and is hitting new highs every other day. What’s going on?

We know that the stock markets generally don’t react to emotional outbursts of citizens on issues that periodically seem to rile them. It normally keeps its temper tantrums and exuberance for events that it thinks will impact the profitability and growth of the companies listed on it in particular and the overall growth of the economy in general. So is the market irrationally exuberant or is it just looking forward, out of the current mess, at the second half of 2020?

There are several reasons that the stock markets are feeling happy. First, there is a steady pipeline of raw material, or money, that is coming to the market from India and abroad. Foreign portfolio investors have poured over 54,000 crore into Indian stocks in financial year 2020, up from an outflow of 88 crore in the last financial year. The nature of these funds is that they seek the stocks in the indices or out of the large-cap basket of stocks. Remember that pension funds and other foreign institutional investors have rules around market-cap thresholds that they need to stick to. This drives up prices of the broad market index stocks. Similarly, the domestic institutional pipeline that brings retail money to the stock market is also getting thicker. Retail investors are pouring in over 8,000 crore a month (and rising) into the stock market through their new love—the SIPs, or an innovatively packaged rupee-cost averaging strategy for a mutual fund. The National Pension System (NPS), unit-linked insurance plans (Ulips) and the Employees’ Provident Fund (EPF) are the other pipelines that get money to the market in a sustained manner every month.

Two, fund managers are not going to pour in money into a market they think is poised to fall into a deep trough. Foreign investors have a choice of asset classes and markets and need not bring their money to India. Mutual funds too have the option to tactically hold on to cash for a while if the fund managers think the market is over-hyped. Cash levels in mutual funds are at an average of 3% of the total assets under management over the past one year. The high cash holdings of over 20% over the past few months seem restricted to a few schemes of a few fund houses.

Three, the market is sensing a bottoming out of the current slowdown and believes that the effect of several reform measures will begin to kick in by the second half of FY21. It is also anticipating a budget that puts money in the hands of the people to spend, and is hoping the government breaches the fiscal deficit targets to pump prime the economy.

But isn’t there a flight of smart money to the safety of blue-chips from mid- and small-caps, as some market experts have argued? Looking at the latest data on the returns on mid- and small-caps, it does not seem so. The two categories bled all of last year with negative returns, the Nifty benchmark indices across small- and mid-cap categories are showing double-digit returns for the last three months. So no, there is no run to the safety of blue-chips. And anyway, when big money runs to safety, it does not run to the same asset class; it moves to bonds and gold, and during the 2008 North Atlantic Crisis, moved to paintings!

What we can take away is that the markets are up due to money pouring in sensing an economic recovery in the future. But remember that short-term volatility is a part of stock market investing. You should belt up and only be in the market if you don’t look at the indices and your net worth every day.

Monika Halan is consulting editor at Mint and writes on household finance, policy and regulation

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