Bhuvan Bhaskar
On Tuesday (January 25), the stock market gradually closed at the highest level of the day after recovering from its initial fall. Earlier on October 19, the Nifty had seen a fall of 2000 points during nearly 40 trading sessions in the fall, which started after touching the high of 18604. But in the sharp recovery that came after touching the low of 16410 on December 20, in just 20 trading sessions, the Nifty reached very close to the old high and when it seemed that the Nifty could once again touch a new high, only then again The decline started from the day and the index broke 1000 points in just 6 trading sessions.
Even though the Nifty closed with a gain of 0.75% on Monday, improving about 450 points from its low level, but investor confidence in the market seems to be shaken. Nifty touched a low of 7511 on 24 March 2020 in a big fall before that and for the first time after that, the stock market is showing a correction phase. In such a situation, the question has become intensified whether this fall is a buying opportunity or is it the beginning of a downtrend in the market?
The answer to this question is not very difficult. Even though the third wave of corona has been attributed to this decline, it has only acted as a trigger. There is no doubt that the stock markets were operating at their highest valuations and a ‘healthy correction’ was being expected for a long time. Ahead of the recent fall, a study by Kotak Mutual Fund estimated the market cap to GDP ratio at 112% during 2021-22 as against the last 10-year average of 76%.
Similarly, the Nifty’s PE (price-earnings ratio, which is calculated by dividing the index’s earnings of 50 Nifty companies) stood at 20.2, while the average PE for the last 15 years stood at 18.2. Obviously the valuation of the market is very high and if the Nifty falls by 2000-3000 points (about 15%) from here, then it will not be a big deal.
Against this logic, it can be said that markets can stay up for a long time even at high valuations and a downtrend, though a real possibility, has no definite formula as to when it will occur. In such a situation, investors can miss out on a valuable opportunity waiting for further downside. Therefore, it would not be right to adopt a strategy towards the market on the basis of valuation alone.
After this, let’s talk about the second most important factor of the market’s bullishness. A lot of the time, the things we spend money on, the more factor that works than how much money we have to spend. This is called liquidity in the language of the market. And this is the second factor that weighs heavily on each valuation.
During the sub-prime crisis of 2008, it seemed as if the entire economic structure of the world was going to collapse. Along with the world, the stock markets of India also started declining in January 2008. In just 10 months i.e. till November 2008, the valuation of Nifty fell to one-third. Central banks all over the world opened their printing presses to create liquidity in the economy. Millions of dollars were poured into the market under the leadership of the US Fed, as a result of which we saw how the world markets had recovered from touching lows within just a year and in just 2 years, in November 2010, the market was one Once again reached its old height.
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The conclusion is that valuations don’t matter much if there is enough liquidity and markets can trade at higher valuations for a longer period of time. An example of this was also seen in 2020. In March 2020, when the whole world was trembling with fear due to the first wave of Corona, then all the buyers in the stock markets surrendered. In the same month, there was a huge fall in the stock markets and by March 24, 40 percent of the valuation of Nifty was over in the sell-off that started from February 12, 2020. The market started rising from 25 March. It is a funny fact that unprecedented lockdowns also started in India from the same day which caused historic damage to the economy in the next full quarter i.e. April-June 2021.
The economy shrank more than 22 percent in the quarter, but the stock market continued to rise. And they kept on increasing till the fall in October last year. The Nifty touched a high of 18604, rising from a low of 7511 on March 24. What happened is that the stock market grew two and a half times, while the economy is still struggling. The answer is once again the same – liquidity. After the first wave of Corona, once again banks around the world opened their coffers.
According to a report by Mint, the number of notes printed by the US Fed since the beginning of 2020 is more than the total number of notes printed in its previous 106 years in terms of count. It can be understood from this figure that as of January 1, 2020, the total assets of the Fed were $ 4.17 trillion, which increased to $ 8.66 trillion by December 8, 2021.
Similarly, the Reserve Bank of India and the Narendra Modi government at the Center also announced a relief package of Rs 20 lakh crore in May 2020. It is obvious that all this money roamed somewhere and reached the stock markets and the valuation ceiling kept increasing. But there is a very basic rule in economics that when a lot of money chases less resources, the price goes up. This situation is called inflation or inflation rate in economics and it is such a ghost that central banks panic more than every government and governments in the world.
From the beginning of 2021, retail inflation in the US started showing an increase. Clearly, this was an alarm bell for liquidity. Federal Bank decided to put the brakes on its bond purchase plan to reduce liquidity. As of November, the Fed was buying $120 billion in bonds a month, which it decided to reduce by $15 billion a month. That is, by July, bond buying was to be completely stopped. After that it was likely that interest rates would start rising gradually.
But when retail inflation for urban consumers in the US hit 6.8% in November 2021, US Federal Bank was in a tizzy. Prior to this, exactly 40 years ago, in June 1982, retail inflation in the US had reached this level (7.1%). The Fed revised its old plan and doubled its bond purchase cuts to $30 billion a month. That is, by March 2022, the Federal Reserve’s bond purchases will stop completely. The Fed has also made it clear that it can raise interest rates 3-4 times during 2022 and it will start from March.
These decisions and their repercussions in the US are sure to have a direct and clear impact on the Indian stock markets as there is hardly any doubt about the role of Foreign Institutional Investors (FIIs) in the Indian stock markets. For the record, from April 2020 to September 2021, when the stock market indices rose nearly 150%, the net investment of FIIs in Indian stock markets was around Rs 1.60 lakh crore, while domestic institutional investors (DIIs) made over Rs 80 thousand crore. It was a net sale.
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It is clear that now that liquidity is going to dry up, on which the Indian stock market was touching new heights every day. In such a situation, sitting in the hope that the stock market will still climb to the old heights will be like building a fortress in the air. Apart from this, some other threats have also been faced, in which Russia’s attack on Ukraine is prominent. If this happens, crude oil prices will rise sharply and India’s financial deficit will also increase. Overall, the Indian stock market seems to be sitting on the cusp of a steep decline and investors who turn their backs on this truth should be prepared for a major setback.
(The author is an expert in agriculture and economic matters)
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