5 Possible Reasons For Why Stock Markets Are Booming Despite Poor Economic Conditions

On 3 July, Indian stock markets closed higher for the third straight day even as daily count of COVID-19 cases in India has been making new records.

In the US, S&P 500 index saw its fastest-ever 30 percent decline in March from a record high, while in the first week of June, the index rose 37.7 percent in 50 days, the fastest rally in the history in such a short period.

Why has there been such a dramatic recovery seen in stock markets even as economists are forecasting the worst economic contraction since the Great Depression in 2020?

The extreme volatility seems to show a clear disconnection between the economy and the markets. A similar recovery in the stock markets was seen after the 2008 financial crisis, however, the recovery took much longer, that is 17 months.

Markets are generally seen as a reflection of the state of the economy or the profits of corporates listed on the stock exchanges, but it is not always so.

1. Optimism

Some believe that markets portray the future or the mood of the investors rather than the economy. It appears that investors believe that the troubles of the economy will be short-lived and economic activity will make a V-shaped recovery. Investors are optimist of the recovery of a global economy disrupted by a public health crisis rather than a financial crisis. Central banks also appear to be better prepared than the 2008 crisis to support their countries.

Further, PMI, unemployment rate and other economic indicators have also shown signs of recovery in the month of June.

 

2. Interest rate cuts

Central banks around the globe, including the Reserve Bank of India (RBI), have taken several monetary decisions like cut in repo rates, limited or unlimited purchases of all sorts of bonds to provide enough liquidity and push businesses and households to take more risks and, in turn, revive the economy. Investors have co-related the low cost of equity with that of lower interest earnings from risk-free investments like FD, government bonds and have chosen to invest in the former.

3. New Money

Some believe that new individuals investors with cash to spare are placing their bets in the stock markets, thanks to easy investment tools using just one's smartphone.

Talking about the increase in trading volumes amid a nationwide lockdown, Angel Broking's CEO Vinay Agrawal told Moneycontrol that "due to the correction in the market, retail investors are finding an opportunity to enter at discounted levels, especially in many of the bluechip companies. Also, since most of the businesses have shifted from conventional offices to working from home in the last three months, a good part of the working population has got some extra time to learn about financial markets and make investments. Both these scenarios have collectively enticed more population to participate and hence we are seeing a surge in opening of demat accounts especially with discount brokers."

In fact, investors have been causing meaningless rallies in some stock prices despite weak fundamentals. For example, the over 8000% surge in Ruchi Soya's share price, the company that filed for bankruptcy last year.

4. Business as usual for tech companies

For companies that are well placed virtually haven't not been affected by the pandemic. E-commerce giants like Amazon or telecom companies like Reliance Jio and Bharti Airtel have benefited from the work-from-home culture. It is largely the companies in manufacturing and retail that have faced disruptions in production as well as sales due to the coronavirus pandemic.

In fact, Reliance Industries Limited, the parent company of Jio Platforms hit another new all-time high on 3 July after announcing its 12th deal in 11 weeks from a line of foreign investors. The conglomerate has been a large contributor to gains seen in Sensex and Nifty 50, despite weakness in financial stocks. The index heavyweight has reported all 12 FDI deals for its digital arm amid the coronavirus crisis.

5. Positive development in drug and vaccine trials

Large pharma companies have been reporting positive results about trials conducted for vaccine and COVID-19 drugs. An early trial of the experimental coronavirus vaccine from Pfizer Inc and BioNtech SE showed it's safe and prompted patients to produce antibodies against the virus.

Also, anti-viral drug remdesivir has also been authorised by health departments of many countries for the treatment against coronavirus including India and very recently the European Commission.

Word of caution

While the stock markets have surged, the rally is getting narrower between March and now. It is possible that the rising pattern is short-term and will terminate considering the fast-rising infection numbers in India and the US which could prompt lockdowns (like the one announced in Mumbai this week).

While there may be some economic indicators of recovery, markets are still largely moving on hope rather than on any real change in the ground realities.

In a recent report, SBI economists said that there is a weak linkage between buoyant markets and economic recovery and the phenomenon largely reflects "irrational exuberance", the economists wrote in a note, attributing the same to easy liquidity made available by RBI.

"Beautiful markets do not signify a beautiful economy," they said.