Why economy falling but stock market rising?

 STOCK MARKET AND ECONOMY

As you can see, between April to July last year, while the economy was falling, the stock market was rising. It’s due to two reasons. First, the stock market isn’t about the entire economy. Paul Krugman, a Nobel-Prize-winning economist, suggests that the stock market is about one piece of the economy i.e., corporate profits. The second reason: the nature of the stock market and economy are different. The stock markets are forward-looking and look towards the future. Whenever someone invests in the stock market, they think about the future of the corporates. Several investors in India believe that once the vaccine is readily available and when the lockdown lifts, the corporate lifts, the corporate profits will recover. However, the economic indicators are backward-looking. As the GDP data tells us that what happened in the previous quarter or year. So, the stock markets are forward-looking, while the economic indicators are backward-looking.

WHY IS THE STOCK MARKET RISING?

WEALTHY PEOPLE

There are three reasons why the Indian stock markets have been rising during the pandemic. The first reason is the wealthy people of the world. During the pandemic, the rich have cut their spending. We can use the data from America as an example since there are no such data available in India. Between May and June 2020, the top 25% of the richest Americans cut their spending significantly. This isn’t surprising as the travel industry, restaurants, and shopping malls are shut. Since they aren’t spending the money, they can invest it somewhere. During an economic crisis, the most common response of a central bank is to lower the interest rates. This makes it easier for the commoners and businesses to get a loan and then spend the money. This way the economy recovers. But there’s another outcome too. But there’s another outcome too. Tara Sinclair, an economics professor at George Washington University, suggests that when interest rates are low, the stock markets become a better option for wealthy people around the world to put their money than alternatives like bonding and savings. The central banks of rich countries have lowered interest rates. Hence, their rich are investing in foreign stock markets e.g., India. In 2020, the net inflow from foreign investors was Rs, 1.4 trillion, the highest ever since 2002.

DIGITIZATION

The second reason behind the growth of the Indian stock market is the increase in digitization, which has particularly helped technological companies. According to NASSCOM and McKinsey, the world’s digital adoption has jumped by 3-5 years due to pandemic. Indians are readily adopting Zoom, social media, streaming services, and digital payments. For example, digital payments increased by 80% in 2020. And more than 1 million provision stores have begun to digitize. The increased digitization attracted foreign investment in companies like Jio. In 2020, Jio manages to raise over Rs. 1 trillion. In fact, Jio attracted 50% of all private investments made in 2020. Hence, the SENSEX IT index outperformed the general SENSEX index last year. And technology stocks aren’t the only asset class that flourished during the pandemic. The other asset class that flourished is cryptocurrency. Since December 2020, the value of 1 Bitcoin has doubled from nearly 130,000 to 260,000. Cryptocurrency has not only been accepted by the common people, but also by the big institutional investors who used to skeptical about cryptocurrency. If we discuss regulations, a question might arise: Isn’t cryptocurrency banned in India? No, that’s not true. Investing in cryptocurrency isn’t forbidden, but you can’t buy things using cryptocurrency. So, you can invest in cryptocurrency using 3^rd party platforms.

NEW INVESTORS

The third reason behind the rise in the stock market is the increase in new investors. Remember this graph that we showed earlier about the rise in the Dematerialized accounts? During the 2020 lockdown, many students, and youngsters, who had enough money and time, started investing in the stock market. K Sannet, a 19-year-old youngster, said he loves investing in the stock market and he has asked his friends to start investing too. Similarly, Srikanth, a 21-year-old graduate, said he wasn’t familiar with the stock market, but as he had enough time during the lockdown, he started reading about it. He said that he started to understand the market better with the help of YouTube videos and books. And before the market opened, he would do 10-20 minutes’ research before trading. What motivated the Indian youth to invest in stocks? While in the US, platforms like Robinhood and Reddit motivated people to invest, similarly, Indians are getting motivated by YouTube influencers, private chat groups, and new trading apps. Prasad, the founder of a popular YouTube channel, said many contacted him during the lockdown and asked how they could invest. His friends asked about investing in mutual funds and equities. Even an auto-rickshaw driver asked how he could set up a mutual fund with Rs. 500 a month. The same goes for the private chats’ groups too. 25-year-old Aaron Joseph shared that there are several conversations on Telegram about how people can get rich using the stock market. Moreover, several mobile trading apps in the market have made stock investing easy. Zerodha, a popular app, revealed that in the first quarter of 2020, it only had 250,000 new investors. But by the second quarter, the number rose to 500,000. How do these apps help? An investor said that it’s become easier to open an account. You don’t need to go out of your home, you don’t need to learn about complicated brokerage charges, and you don’t have to print 500 documents.

IMPACT OF THE RISE IN THE STOCK MARKET

Therefore, people are drawn towards the stock market. But stock market investments are risky too. The major risk could be Bubble. As the stock prices have risen dramatically around the world, many fear that it could be a bubble. Alicia Garcia-Herrero, an economist, remarks that by lowering the interest rates, the central banks are pushing the investors towards risky assets. This isn’t new. The central banks have been doing it since 2018. This is a major risk for India’s financial system. In its Financial Stability Report, the RBI asserted that increased valuation of financial assets can impair the financial stability of any country. Not everyone agrees with this. Mark Mathews of Julius Baer, a large wealth management company said that the Indian stock market is not overvalued, and the prices fall closer to the real prices. Only time will tell if we’re in a stock market bubble or not. It’s difficult to predict it with 100% accuracy. But what’s clear is that there’s no correspondence between the stock market and the economy. The stock market indicates the situation of the wealthy people as they are the shareholders. Meanwhile, the working class is facing unemployment and poverty due to the pandemic. This indicates that the crumbling of the economy due to the pandemic has affected the poor the most.

Rohan Chandra

B.COM III