MAKING SENSE OF THE MARKET LEAP
Outlook Money|October 2021
Low-interest rates, corporate deleveraging and retail frenzy push Sensex above 60,000 in September. Let’s understand the rationale behind the bull run and why retail investors need to be cautious amid the euphoria.
Rajiv Ranjan Singh

The dichotomy between the economy and the stock market has been one of the biggest enigmas of the past 18 months. The period will be remembered as the best for the stock market, but also one which saw the highest gross domestic product (GDP) contraction in the history of India.

The fear instilled by the Covid pandemic pushed the stock market in a panic zone in March 2020, but that also sowed the seeds of the next bull run. In the next 18 months, the BSE Sensex zoomed over 34,000 points from its March 2020 low of 25,639. Similarly, the Nifty moved up around 11,300 points from its March 2020 low of 7,511.

Remarkably, in this calendar year, the Nifty 50 index climbed to its all-time high in 46 out of 180 trading sessions. The Nifty index is a composition of 50 stocks, while the Sensex contains 30 stocks.

The stock market is being supported by adequate liquidity from foreign investors. Thanks to the massive balance sheet expansion by the US central bank, the Federal Reserve, and the European Central Bank (ECB), the world is awash with liquidity. Every month, the Fed is buying bonds worth $120 billion. Its balance sheet is $8.45-trillionlarge, a 102 per cent increase on a year-on-year basis. Never in history has any central bank expanded its balance sheet by $4 trillion in a single year. ECB’s balance sheet was worth €8.2 trillion at the end of September, according to Refinitiv. In search of return, money is pouring into high-growth markets like India, which attracted $31 billion in the last one year ending July.

Speaking with Outlook Money, Vijay Bhambwani, head of research, behavioural technical analysis, Equitymaster, says the market is running purely on liquidity. “If a defaulting country like Peru after raising the coupon rate to 3 per cent can get $10-11 billion in a short span, then why won’t the world’s fifth-largest economy with over 6.25 per cent coupon rate get the inflow many times over Peru,” he reasons.

In a single month, the Nifty has returned over 7 per cent more than what the bond markets offer on an annual basis. In the last one year, the Nifty has returned over 65 per cent.

That, coupled with low interest rates on safer investment options, is pushing retail investors into the there-is-no-alternative-to-equities zone. Naturally, the stock market has caught their fancy. In the June quarter, an average of 2.45 million demat accounts were opened per month, according to Securities and Exchange Board of India chief Ajay Tyagi. On average, about 10 lakh new demat accounts were opened per month in FY21.

Apart from liquidity and large inflow from both domestic and foreign institutional investors, are there other reasons that are leading to higher market valuations?

Why Is Nifty Getting A Premium?

Nifty was trading at 21 times FY23 earnings around September-end. The average one-year forward earnings multiples for the past five, 10 and 15 years was 20, 18 and 17.5, respectively. As indicated by the data, Nifty is trading at a higher premium now as compared to its historical performance. Nifty is also trading at a 68 per cent premium to emerging markets’ average earnings multiples, according to a Nomura report, dated August 30, 2021.

So why is Nifty commanding such a high premium? The first reason is strong corporate earnings that are not volatile in nature. Another is moderate inflation of 4-5 per cent in a world where even 2 per cent inflation is too much to ask for. For instance, in the US, the 10-year sovereign bond is yielding just 1.34 per cent, while $16.5 trillion of bonds globally have a negative yield.

However, rising inflation could upset the Nifty premium. Rising inflation forces monetary authorities to increase interest rates. The adverse impact of inflation on stock prices compresses earnings multiples as rising interest rates lead to equity derating.

Right now, India’s inflation is both structurally low and cyclically tame, and is unlikely to be a cause of any major equity selloff, according to a report by Canada-based BCA Research, titled ‘Can Inflation upset the Indian Applecart?’, which was released on September 9, 2021. The repeated resilience of indices in the face of negative news, such as Covid-related stress, global supply chain disruption, rising commodity prices and the Evergrande crisis, begs an explanation for such an impressive performance and leads to some key questions. Are the current market valuations justified? Why is the Nifty trading at a premium?

What’s The Rationale Behind The Bull Run?

Experts are unanimous that though the strong inflow of capital along with cheaper credit is feeding excessive optimism into the market, it is still far away from a bubble. Market participants believe that re-rating of many sectors, especially banking and metals, and corporate deleveraging on the back of strong earnings growth is fuelling the upward movement of the index.

For starters, it is important to understand the two factors that decide the direction of the equity market— price of money or the interest rate and the expectation of corporate earnings growth.

For the stock market to move up, interest rates must fall, and corporate profit must rise. Between February 2019 and September 2021, the Reserve Bank of India’s (RBI) repo rate came down from 6.5 per cent to 4 per cent, the lowest level since 2000. Slowly and steadily, banks passed on the reduced rates to corporates and households. Lower interest cost also meaningfully reduced the debt burden for heavily leveraged Indian corporates and improved their profits.

Corporate India’s deleveraging exercise: With an improved income statement, corporate India followed a massive deleveraging exercise and cut down its net debt (gross debt minus cash) by approximately one-third (30 per cent) and gross debt by almost one-fifth (17 per cent) in FY21.

The biggest overhang on the corporate balance sheet was debt and, for a change, instead of amassing debt, corporate India was repaying loans. A leaner balance sheet has become the mantra for a host of companies now.

In FY21, Reliance Industries reduced its gross debt by ₹67,656 crore, while Tata Steel lowered it by around ₹31,000 crore, the largest deleveraging exercise by corporate India. At the group level, Reliance’s gross debt came to ₹2.43 lakh crore in FY21 from ₹3.1 lakh crore in FY20. Tata Group’s (excluding Tata Motors) gross debt reduced by ₹45,853 crore to around ₹1.34 lakh crore in March 2021 from Rs 1.8 lakh crore in March 2020.

Data from Capitaline shows that, overall, 750 companies have reduced gross debt by ₹3 lakh crore to ₹14.7 lakh crore in FY21 from ₹17.71 lakh crore in FY20. The net debt is down by ₹4 lakh crore to ₹9.5 lakh crore in March 2021 from ₹13.51 lakh crore in March 2020.

The top five gross debt reducing sectors in FY21 were refineries (₹75,823 crore), steel (₹44,635 crore), textiles (₹14,384 crore), fertilizers (₹10,780 crore) and power generation (₹10,230 crore), as per Capitaline.

Sandeep Shenoy, a market veteran and the executive director of Mumbai-based investment boutique firm Pioneer Invest Corporation, says the saving on the back of low-interest rates and the rapid pace of deleveraging by corporate India are fuelling the market rally.

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