The typical December Santa rally came a month later for Indian stock markets with the Sensex touching historic highs of 50,000 on Thursday. The phenomenal rally from 40,000 to 50,000 took a mere 100 days, but the journey is remarkable considering the record depths the Sensex had plunged last March to 25,000.
A combination of strong capital inflows, low rates, leaner corporate balance sheets and vaccination drive along with government measures all contributed to the milestone. Market capitalisation crossed Rs 197 lakh crore or $2.7 trillion on Wednesday, or about 115% of GDP despite forecasts of over 7% GDP contraction this fiscal. So are markets engineering their own boom or is the ongoing rally here to stay?
These questions are bothering investors and even the RBI Governor Shaktikanta Das. Last month, he warned about stretched valuations posing risks to financial stability. He also flagged, albeit indirectly, the growing disconnect between financial markets (read equities) and the real economy. If we recall, just last February, global markets were on the dragon’s tail with S&P to Nikkei seeing a bloodbath fearing the pandemic.
But now, both global and local factors are aiding the ongoing rally. Strong global cues following a new US administration, benign global liquidity, faster than expected economic recovery and anticipation of a dream Budget are keeping the hopes of investors high. This momentum is bred into banking, PSU, metals, auto and IT stocks, while some believe midcaps will soon join the party. Lastly, domestic liquidity is abundant and FIIs are buying Indian equities with added fervour.
That said, one of the oddities of markets is that it isn’t the economy. Even though equities are buoyant on improved earnings outlook, it is partly due to expenditure cuts. While government spending assures demand boost, it will prompt fiscal deficit to breach record highs. As for the financial system, even the RBI itself is unaware of the actual extent of gross NPAs. Lastly, valuations at current levels are indecently high, which only confirms that unless consumer demand, investments and government spending work in tandem, the market rally may soon peter out.