If nothing else is true, the BSE Sensex – or the Bombay Stock Exchange Sensitive Index – is aptly named, and nowhere was that more evident in recent times than during the Budget speech of Finance Minister Arun Jaitley on 1 February.
For those two hours, there is no better display of the contrasting visions – or versions – of the stock market as a jumpy, nervous Nellie on her first big date, and a cold relentless machine that factors in all the information all the time, a la Enrico Fermi’s Efficient Market Hypothesis. And that should raise several questions we usually ignore as irrelevant.
First, why do we insist on thinking of the ‘market’ as consisting on one index of 30 stocks in a universe of more than 5,000 companies? What is worse, in many quarters people actually behave and speak as if the stock market represents the state of the economy itself: Take politicians, who are constantly reassuring market participants about the positive impacts of policies, and when they are worried about the market’s effect on their electoral fortunes.
Second, why do we call the stock market a barometer of the economy? Let’s look at the math. Agriculture accounts for nearly 18 percent of GDP; almost none of it is in listed companies. Medium and small enterprises – the MSME sector, so to speak – is another big chunk of GDP – including services account for another 35 percent, according to the Ministry and Micro Small and Medium Enterprises. Again, almost none of these firms are listed on any stock exchange, and then, there are a large number of private unlisted firms, too. How accurate can a ‘barometer’ be when it virtually ignores more than half the economy?
Third, why do we wilfully ignore industrial reality? Capacity utilisation across all industrial sectors is roughly 65 percent, new capital investment in has been declining consistently: data from the Centre for Monitoring the Indian Economy (CMIE), a think tank, shows that in 2017, new capital investment proposals amounted to Rs 79,000 crore; compared that to Rs 1.42 lakh crore in 20156, Rs. 1.53 lakh crore in 2015 and Rs 1.62 lakh crore in 2014. Add to that the balance sheet crises – banks and companies who borrowed from them – in the economy, and the state of the economy is not a pretty picture.
Fourth, why do we think all that liquidity – in this case, a significant amount of foreign portfolio inflows – coming into the stock market is necessarily a good thing? When that kind of liquidity flows into the real economy, everybody begins to worry about consumer inflation; the Reserve Bank of India (RBI) steps in and prevents inflation from running amok by using the tools at its disposal. In the equity markets, there's no one making the distinction between stock price inflation and so-called 'better valuation'.
Typically, stock market booms reflect economic health and growth: Companies make more money, their intrinsic value increases, and stock prices rise – the ‘fundamental’ perspective on the stock market if you will. But in a boom fuelled by extraordinary amounts of liquidity, this becomes a ‘fund-a-mental’ view of the market. It’s not equity valuation that matters, it’s stock prices.
Common sense and experience tells us that a growing economy is one in which prices are falling; there is confidence, consumer sentiment is high and people spend money. That translates into higher company revenues, better stock price valuations and higher stock prices. But right now, none of that is happening, apart from stock price increases. If the RBI’s analysis is anything to go by, inflation is barely in check, and the ‘twin-balance sheet problem’ has hit both earnings, and earnings growth is low. Consumer or business confidence is not exactly high, if surveys are anything to go by.
Fifth, how do we know tell the difference between value and price in today’s market conditions? One test is the IPO market. Data from Chittorgarh and Prime Database (two portals that collate IPO data) show that from Rs 1201 crore from 7 issues in 2014, IPOs raised 11362 crore from 21 issues in 2015, 26,372 crore from 27 IPOs in 2016, to Rs 75,475 crore from 38 offerings in 2017.
Any investment banker will tell you that the best time to get a great price for your IPO is when the markets are booming (he will probably call it best valuation). The test is in the after-listing performance of the companies.
A January 2015 analysis conducted by Mint, a newspaper, found that of 178 IPOs made since 2008, two-thirds were trading below the price they were listed. In a follow-up report in April 2016, they found that 198 out of 292 companies that made IPOs in the previous decade were trading at below listing price, after trading higher on the day of listing itself. A better illustration of the difference between value and price will be hard to find.
The stock market is not the economy; a look at the pages of the daily newspapers will tell you that (though some experts argue that media coverage also exercises great influence on public perceptions about the stock markets). Assuming otherwise poses two serious risks, one to your savings and another to the economy at large.
Stock prices are at their current heights because of unprecedented central bank stimulus that has prevailed across the world in response to the global financial crisis of 2008 (which may now be changing). Investors should be careful not to be misled into thinking this reflects the actual state of the economy and buying stocks in a hurry.
From a policy standpoint – and here, the Union Budget takes on huge significance – we cannot be led into thinking that higher stock prices should be the goal of economic policy. It is not as far-fetched as you’d think. Look at the analyses which suggested that the stock market’s adverse reaction was a function of ‘farmer-friendly’ policies in the Budget.
Neither are high stock prices proof that policies are working. If policymakers believed that, they’d be tempted to just sit tight, rather than undertake true structural reform that becomes the foundation of sustained, long-term economic growth. We will build up more debt, particularly through increases in government borrowing. All debt is borrowing from the future to satisfy current need; at the very least it should be judicious.
Bernard Baruch, American financier, economic adviser to Presidents Woodrow Wilson and Franklin D. Roosevelt, and philanthropist once said that the main purpose of the stock market was to make fools of as many men as possible. Don’t let it fool you about the role it actually plays in the economy.
(The writer, a former journalist, is a communications consultant. He tweets @shrisrinivas)
Published Date: Feb 06, 2018 11:03 AM | Updated Date: Feb 06, 2018 11:32 AM