Will Mr. Market Do A Humpty Dumpty?

The question that is uppermost on anyone who tracks the market is, why is the Indian stock market booming despite such grim news on the Covid front?

There are more buyers in the market than sellers. A simple no-brainer answer. So the question follows, why are so many people buying stocks while the economy is being ravaged by the second wave?

It is a bit confusing and doomsday theory supporters have been sitting on the sidelines. A crash and burn have been predicted by bears for quite some time but the market has not obliged.

So why is the market going up? No one can have a clear answer to the why, but here are some possible reasons or a combination of these.

Although the mental trauma because of the covid’s 2^nd wave is unbearable, the phased lockdown has somewhat saved the economy. Unorganised or small and medium enterprises may be reeling with the slowdown but the organized ones listed in the stock markets are actually turning up good profits.

Physical covid impacted sectors like entertainment, travel, airlines are bleeding but the hope is they will turn around quickly with revenge shopping and revenge travel as the lockdown ends. Some sectors and some companies are getting stronger and the weak are getting weaker in a K-shaped recovery.

Right now, we have a scarcity of vaccines, the hope is that by the end of the year we will get there, vaccinate a majority of our population and move on like the western world. Stock markets are drunk on optimism that the end of the pandemic is close and life will be back to normal by end of the year.
A long time ago, when we used to work from an office, gossip said that the week after payday was when almost everyone splurged. Clearly, if pockets are bursting it is easier to let go. Similarly, Central Banks all over the world are filling the pockets of institutions by buying bonds and dumped cash in their coffers to make sure there is no tightness post the pandemic.

These institutions flushed with funds by the Central Bank look to invest where they can to earn a return. Interest rates and thereby bond yields are low. Hence they consider other assets like lower-rated bonds, stocks, gold, real estate, crypto, money starts flowing into them as return expected is Govt bonds + something, hence almost all assets are booming.

This is a simplistic explanation of liquidity propping up markets.

Liquidity/ money driving into stocks is raising prices. Stock market booming attracts more money. It’s a self-fulfilling prophecy until it breaks down. India has got record inflows from foreign portfolio investors of 35 bn $ this financial year. It follows that dollars coming in has chased higher prices. Lately in the last couple of months post the second wave foreign investors may have found other emerging markets more attractive compared to India, so the inflows have slowed down.

There has also been a humongous rise in retail investor’s participation last year. It may have been a combination of zero brokerage + idle minds + an opportunity to make a quick buck which may have fueled it. The new investors trading has contributed to the rally.

A few good policies supporting growth, a central bank willing to do whatever it takes to support the economy, and an almost unlimited supply of money have supported markets.

It may go on for some time but eventually, stock market returns will have to follow the reported earnings of corporates. The market can run ahead but if expectations are not met, it will fall with a thud.

What should one be watchful of?

Imo, observe the mother market i.e. the US, a crash there typically may change sentiments here. Keep a watch on the movements of interest rates, Central Banks hint at raising interest rates and/or reduce the bond purchase program and thereby reduce “liquidity” i.e. the flow of money rushing out to buy everything in sight. Inflation, if it rises a lot and seems sticky will be another red flag. Any geopolitical tension, a new variant of the virus. .and some unknown, unknown can spoil the party. So be watchful.

Humpty dumpty may keep climbing newer walls for a pretty long time and sit there or may topple someday.