Market mayhem: If you link Sensex, Nifty

bloodbath to Budget and economy, you are

making a fool of yourself

Srikanth Srinivas
Firstpost6 February 2018
12 comments

Any investment banker will tell you that the best time to get a great price for your IPO is when the markets are booming (he
will probably call it best valuation). The test is in the after-listing performance of the companies.
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If nothing else is true, the BSE Sensex € " or the Bombay Stock Exchange Sensitive Index € " is aptly
named, and nowhere was that more evident in recent times than during the Budget speech of Finance
Minister Arun Jaitley on 1 February.

For those two hours, there is no better display of the contrasting visions € " or versions € " of the sticky
market as a jumpy, nervous Nellie on her first big date, and a cold relentless machine that factors in all
the information all the time, a la Enrico Fermi's Efficient Market Hypothesis. And that should raise several
questions we usually ignore as irrelevant.

First, why do we insist on thinking of the 'market' as consisting on one index of 30 stocks in a universe of
more than 5,000 companies? What is worse, in many quarters people actually behave and speak as if the
stock market represents the state of the economy itself: Take politicians, who are constantly reassuring
market participants about the positive impacts of policies, and when they are worried about the market's
effect on their electoral fortunes.

Second, why do we call the stock market a barometer of the economy? Let's look at the math. Agriculture
accounts for nearly 18 percent of GDP; almost none of it is in listed companies. Medium and small
enterprises € " the MSME sector, so to speak € " is another big chunk of GDP € " including services
account for another 35 percent, according to the Ministry and Micro Small and Medium Enterprises.
Again, almost none of these firms are listed on any stock exchange, and then, there are a large number
of private unlisted firms, too. How accurate can a 'barometer' be when it virtually ignores more than half
the economy?

Third, why do will wilfully ignore industrial reality? Capacity utilisation across all industrial sectors is
roughly 65 percent, new capital investment in has been declining consistently: data from the Centre for
Monitoring the Indian Economy (CMIE), a think tank, shows that in 2017, new capital investment
proposals amounted to Rs 79,000 crore; compared that to Rs 1.42 lakh crore in 20156, Rs. 1.53 lakh
crore in 2015 and Rs 1.62 lakh crore in 2014. Add to that the balance sheet crises € " banks and
companies who borrowed from them € " in the economy, and the state of the economy is not a pretty
picture.

Fourth, why do we think all that liquidity € " in this case, a significant amount of foreign portfolio inflows € "
coming into the stock market is necessarily a good thing? When that kind of liquidity flows into the real
economy, everybody begins to worry about consumer inflation; the Reserve Bank of India (RBI) steps in
and prevents inflation from running amok by using the tools at its disposal. In the equity markets, there's
no one making the distinction between stock price inflation and so-called 'better valuation'.
Typically, stock market booms reflect economic health and growth: Companies make more money, their
intrinsic value increases, and stock prices rise € " the 'fundamental' perspective on the stock market if you
will. But in a boom fuelled by extraordinary amounts of liquidity, this becomes a 'fund-a-mental' view of the
market. It's not equity valuation that matters, it's stock prices.

Common sense and experience tells us that a growing economy is one in which prices are falling; there is
confidence, consumer sentiment is high and people spend money. That translates into higher company
revenues, better stock price valuations and higher stock prices. But right now, none of that is happening,
apart from stock price increases. If the RBI's analysis is anything to go by, inflation is barely in check, and
the 'twin-balance sheet problem' has hit both earnings, and earnings growth is low. Consumer or business
confidence is not exactly high, if surveys are anything to go by.

Fifth, how do we know tell the difference between value and price in today's market conditions? One test
is the IPO market. Data from Chittorgarh and Prime Database (two portals that collate IPO data) show
that From Rs 1201 crore from 7 issues in 2014, IPOs raised 11362 crore from 21 issues in 2015, 26,372
crore from 27 IPOs in 2016, to Rs 75,475 crore from 38 offerings in 2017.

Any investment banker will tell you that the best time to get a great price for your IPO is when the markets
are booming (he will probably call it best valuation). The test is in the after-listing performance of the
companies.

A January 2015 analysis conducted by Mint, a newspaper, found that of 178 IPOs made since 2008, two-
thirds were trading below the price they were listed. In a follow-up report in April 2016, they found that
198 out of 292 companies that made IPOs in the previous decade were trading at below listing price, after
trading higher on the day of listing itself. A better illustration of the difference between value and price will
be hard to find.

The stock market is not the economy; a look at the pages of the daily newspapers will tell you that
(though some experts argue that media coverage also exercises great influence on public perceptions
about the stock markets). Assuming otherwise poses two serious risks, one to your savings and another
to the economy at large.

Stock prices are at their current heights because of unprecedented central bank stimulus that has
prevailed across the world in response to the global financial crisis of 2008 (which may now be changing).
Investors should be careful not to be misled into thinking this reflects the actual state of the economy and
buying stocks in a hurry.

From a policy standpoint € " and here, the Union Budget takes on huge significance € " we cannot be led
into thinking that higher stock prices should be the goal of economic policy. It is not as far-fetched as
you'd think. Look at the analyses which suggested that the stock market's adverse reaction was a function
of 'farmer-friendly' policies in the Budget.

Neither are high stock prices proof that policies are working. If policymakers believed that, they'd be
tempted to just sit tight, rather than undertake true structural reform that becomes the foundation of
sustained, long-term economic growth. We will build up more debt, particularly through increases in
government borrowing. All debt is borrowing from the future to satisfy current need; st the very least it
should be judicious.

Bernard Baruch, American financier, economic adviser to Presidents Woodrow Wilson and Franklin D.
Roosevelt, and philanthropist once said that the main purpose of the stock market was to make fools of
as many men as possible. Don't let it fool you about the role it actually plays in the economy.