Even as India’s GDP has been shrinking month after month, stock markets are rising to newer heights with every passing day. This dichotomy has been in full glare right since the second quarter of this financial year. An investor who put half their savings in equities in March last year would have surely doubled his corpus by now — an over 100 per cent return. In fact, the dynamics of the stock markets have decoupled from economy. As economy shrinks, jobs come down and so does the demand. As demand dries up, companies fail to find buyers for their products and services. Once sales of services and goods fall, companies incur losses and revenues come down. Dividend payouts by companies to investors also thin out. In normal situation, it would seem that stock prices will be less pricey.
The relentless rise in stock prices now is a very dicey scenario. It looks like a massive bubble is building up, only to burst in our face before long. Why such exact opposites are happening? Are the investors so naïve? Not exactly. These questions and many more like this are coming to mind. One reason for the unexpected rise in stock prices could be the falling wage bills of companies during the pandemic leading to a corresponding increase in the income of business owners. The returns to owners of businesses have gone up sharply while real wages have dropped. So the health of the economy may have gone down, but the returns to the owners have gone up — something that drives the stock prices of companies. We can assume that share prices go up when companies announce that they have reduced their wage bills. Stock markets across the world have been rallying in the midst of the global recession worsened by the coronovirus pandemic. The slump caused a drop in sales of companies because demand has evaporated. Yet, the returns to owners of businesses went up sharply while real wages dropped. The easy money policy by the RBI has also helped in good measure to sustain the market rally. There is enough money for people to borrow and invest in stocks and shares. Another reason why share prices are going up is the accumulated capital of corporates. As demand drops, corporate houses do not make fresh investment in their businesses. Therefore, they return a part of their retained profits to shareholders by giving them higher dividends or through share buy-backs. High dividends push the demand for shares, pushing up prices.
Share-buy-backs also reduce the float (supply) size of the shares in the markets, causing stock prices to go up. At present, real interest on term deposits offered by banks is negative if we factor in over six per cent retail inflation in the December quarter. The rate of interest on a term deposit in any Indian bank does not fetch 5-6 per cent. Therefore, the only instrument that gives positive returns is the investments in stock markets. Availability of easy money by banks, lack of avenues to grow money and allure of stock markets have combined to drive investors to equities markets. Will this rally sustain for long? Not likely. In the medium to long run, this is headed for a bust-up. The earnings of companies are likely to come down as wage bills are headed for a markup. If the tax projections of the government in this year’s budget are any indication, we will see that the size of tax projections is relatively smaller in the Q3-Q4 of the current fiscal. In such situations, markets are bound to get into a phase of correction.