Why is the stock market going up when the economy is going down?

The total collections of the goods and services tax (GST) between March and July stood at Rs 2.73 lakh crore. This is 34.5% lower than what the government earned during the same period in 2019.

The stock market index Nifty 50 has rallied by 53% to 11,648 points between March 23 and August 28. It had touched this year’s low of 7,610 points on March 23.

So, what’s the point in comparing the Nifty 50 with GST collections? The GST is basically a tax on consumption. If the GST collections are down by more than a third, what that basically means is that private consumption is down majorly.

When consumption is down, the company earnings are bound to take a beating. Take the case of two-wheelers and cars. When people don’t buy as many of them as they used to, their production takes a beating. When that happens, it has an impact right down the value chain. It means lower production of steel, steering, glass, tyres, etc. A lower production of tyres means a lower demand for rubber.

A lower production on the whole means lower demand for power. Industrial power largely subsidises farm power and home power (where power is stolen). If industrial power consumption goes down, the losses of state electricity boards go up. When this happens, their ability to keep paying power generation companies goes down. When these companies don’t get paid, they are in no position to repay loans they have taken from banks. So, the cycle works.

Many people buy two-wheelers and cars on loans from banks and non-banking finance companies. When the buying falls, the total amount of loans given by banks also comes down. When banks don’t get enough loans, they need to cut the interest rate on their fixed deposits.

When this happens, people who are saving towards a goal, need to save more. This means they need to cut down on their consumption. Further, people who are largely dependent on interest from bank deposits will see their incomes fall. This means they need to cut down on their consumption as well.

This cycle will also lead to a fall company earnings. A Business Standard results tracker for 1,946 companies reveals that the sales of these companies for April to June 2020 were down 23.1% in comparison to the same period in 2019. The net profit for these companies was down 60.8%.

The stock market does not wait for things to happen. It discounted for this possibility and the Nifty fell by 32.1% between end February and March 23. The market was adjusting for an era of falling company earnings. But it didn’t stay at those low levels and has rallied by more than 50% since then.

The trouble now is that the valuations are way off the chart. The price to earnings ratio of the Nifty 50 index, as of August 28, stood at 32.92. This means that investors are ready to pay close to Rs 33 for every rupee of earning for stocks that make up the Nifty 50 index. Such a level has never been seen before. Not during the dotcom bubble era and not even during early 2008 when the stock market rallied to its then highest level.

Why has the stock market jumped as much as it has? Does this mean that the company earnings will jump big time in the near future? Not at all. The covid-induced recession is not going to go anytime quickly. Also, the pandemic is now gradually making its way into rural India.

So, why is the stock market rallying? The Western central banks led by the Federal Reserve of the United States, the American central bank, have printed a lot of money post February, in order to drive down interest rates and get people and businesses to borrow and spend. The Federal Reserve has printed more than $2.8 trillion between February 26 and August 5. Some of this money has made it into India.

During this financial year, the foreign institutional investors have net invested a total of Rs 83,682 crore into Indian stocks, after going easy on investing in India over the last few years. This is clearly an impact of the easy money policies being run in much of the Western world.

Further, the participation of the retail investors in the stock market has increased during the course of this year. Between December 2019 and June 2020, the number of demat accounts has gone up by 39 lakhs or 10% to 4.32 crore accounts. In fact, between March end, after a physical lockdown to tackle covid was introduced, and up to June, the number of demat accounts has gone up by 24 lakhs.

The latest monthly bulletin of Securities and Exchange Board of India, the stock market regulator, points out: “We have seen a huge surge in participation of retail investors in the equity market in the last few months. The fact that there is also a surge in opening up of demat accounts suggests that many of these retail investors are perhaps first time investors in the stock market.”

With after tax return on bank fixed deposits down to 4-5% when inflation is close to 7%, these investors are coming to the stock market, in search of higher returns.

The question is, with the stock market at all time high valuations, will their good times continue? Or once the dust has settled, is another generation of investors ready to equate stock market investing to gambling? On that your guess is as good as mine.

This article originally appeared in the Deccan Herald on August 30, 2020.

Janet Yellen’s tourist dollars are driving up the Sensex

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Central bankers drive stock markets. At least, that is the way things have been since the current financial crisis started in September 2008, when Lehman Brothers, the fourth largest investment bank on Wall Street went bust.

On March 30, 2016, the BSE Sensex rallied by 438 points or 1.8% to close at 25,338.6 points. What or rather “who” was responsible for this rally? Janet Yellen, the chairperson of the Federal Reserve of the United States, the American central bank.

Yellen gave a speech on March 29. In this speech she said: “I consider it appropriate for the committee to proceed cautiously in adjusting policy.” The committee Yellen was referring to is the Federal Open Market Committee or the FOMC.

The FOMC decides on the federal funds rate. The federal funds rate is the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank on an overnight basis. It acts as a sort of a benchmark for the interest rates that banks charge on their short and medium term loans.

In December 2015, the FOMC had raised the federal funds rate for the first time since 2006. The FOMC raised the federal funds rate by 25 basis points (one basis point is one hundredth of a percentage) to be in the range of 0.25-0.5%. Earlier, the federal funds rate had moved in the range of 0-0.25%, for close to a decade. FOMC is a committee within the Federal Reserve which runs the monetary policy of the United States.

The question that everybody in the global financial markets is asking is when will the FOMC raise the federal funds rate, again? It did not do so when it met on March 15-16, earlier this month. The next meeting of the FOMC is scheduled for April 26-27, next month.

By saying what Yellen did in her speech she has essentially ruled out any chances of the FOMC hiking the federal funds rate in April 2016. This is the closest a central bank head can come to saying that she will not raise interest rates any time soon.

This was cheered by the stock markets all over the world. Yellen basically announced that the era of “easy money” was likely to continue, at least for some time more.

This means that financial institutions can continue to borrow money in dollars at low interest rates and invest this money in stock markets and financial markets all around the world, in the hope of earning a higher return.

This means that the “tourist dollars” are likely to continue to be invested into the Indian stock market. Mohamed A El-Erian defines the term tourist dollar in his new book The Only Game in Town. As he writes: “During periods of large capital flows induced by a combination of sluggish advances economies, robust risk appetites, and highly stimulative central bank policies, emerging markets serve as destination for a huge pool of crossover funds, or what I refer to as tourist dollars.

As Erian further writes: “Rather than “pulled” by a relatively deep understanding of country fundamentals, this type of capital is typically “pushed” there by prospects of low returns in their more traditional habitats in the advanced world.”

The federal funds rate in the United States is in the range of 0.25-0.5%. In large parts of Europe as well as in Japan, interest rates are in negative territory. In this scenario, the returns available in these countries are very low. At the same time, it makes tremendous sense for financial institutions to borrow money at low interest rates from large parts of the developed world and invest it in stock markets, where they expect to make some money.

And India is one such market, where these “tourist dollars” are coming in and will continue to come in, if the central banks of the developed world continue running an easy money policy.

What got the stock market wallahs all over the world further excited was something else that Yellen said during the course of her speech. As she said: “Even if the federal funds rate were to return to near zero, the FOMC would still have considerable scope to provide additional accommodation. In particular, we could use the approaches that we and other central banks successfully employed in the wake of the financial crisis to put additional downward pressure on long term interest rates and so support the economy.”

What does this mean? This basically means that, if required, the Federal Reserve will print money and pump it into the financial system to drive down long-term interest rates in the United States, so that people will borrow and spend more. This was the strategy that the Federal Reserve used when the financial crisis started in September 2008. This basically means that the era of easy money unleashed by the Federal Reserve is likely to continue in the days to come.

Now only if the Modi government could get its act right on the economic front., the tourist dollars would just flood in.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on March 30, 2016

Janet Yellen will keep driving up the Sensex

yellen_janet_040512_8x10Vivek Kaul

The Bombay Stock Exchange (BSE) Sensex, India’s premier stock market index, rose by 517.22 points or 1.88% to close at 27,975.86 points yesterday (i.e. March 30, 2015). On March 27, 2015 (i.e. Friday), Janet Yellen, the Chairperson of the Federal Reserve of the United States, gave a speech (after the stock market in India had closed). In this speech she said: “If conditions do evolve in the manner that most of my FOMC colleagues and I anticipate, I would expect the level of the federal funds rate to be normalized only gradually, reflecting the gradual diminution of headwinds from the financial crisis.” The federal funds rate is the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank on an overnight basis. It acts as a sort of a benchmark for the interest rates that banks charge on their short and medium term loans. What Yellen was basically saying is that even if the Federal Reserve starts raising interest rates, it will do so at a very slow pace. In the aftermath of the financial crisis that started in mid September 2008, when the investment bank Lehman Brothers went bust, central banks in the developing countries have maintained very low rates of interest. The Federal Reserve of the United States, the American central bank , has been leading the way, by maintaining the federal funds rate in the range of 0-0.25%. The hope was that at low interest rates people would borrow and spend more than they were doing at that point of time. This would help businesses grow and in turn help the moribund economies of the developing countries. While people did borrow and spend to some extent, a lot of money was borrowed at low interest rates in the United States and other developed countries where central banks had cut rates, and it found its way into stock markets and other financial markets all over the world. This led to a massive rallies in prices of financial assets. For the rallies in financial markets all over the world to continue, the era of “easy money” initiated by the Federal Reserve needs to continue. And this is precisely what Yellen indicated in her speech yesterday. She said that even if the Fed starts to raise interest rates it would do so at a very slow pace, in order to ensure that it does not end up jeopardizing the expected economic recovery. Yellen went on to add in her speech on Friday that: “Nothing about the course of the Committee’s actions is predetermined except the Committee’s commitment to promote our dual mandate of maximum employment and price stability.” This is where things get interesting. The rate of unemployment in the United States in February 2015 was at 5.5%. This was a significant improvement over February 2014, when the rate of unemployment was at 6.7%. But even with this big fall, the Federal Reserve is unlikely to raise interest rates. Typically, as unemployment falls, wages go up, as employers compete for employees. But that hasn’t happened in the United States. The wage growth has been more or less flat over the last one year (it’s up by 0.1%). The major reason for the same is that more and more jobs are being created at the lower end. As economist John Mauldin writes in his newsletter: “66,000 of the 295,000 new jobs[that were created in February 2015) were in leisure and hospitality, with 58,000 of those being in bars and restaurants…Transportation and warehousing rose by 19,000, but 12,000 of those were messengers, again not exactly high-paying jobs.” Further, in the last few years the energy industry in the United States has seen a big boom on the back of the discovery of shale oil. But with oil prices crashing, the energy industry has started to shed jobs. In January 2015, the energy industry fired 20, 193 individuals. This was 42% higher than the total number of people who were sacked in 2014. As analyst Toni Sangami pointed out in a recent post: “These oil jobs are among some of the highest-paying blue-collar jobs in the country, so losing one oil job is like losing five or eight or ten hospitality-industry jobs.” The labour force participation ratio, which is a measure of the proportion of the working age population in the labour force, in February 2015 was at 62.8%. It has more or less stayed constant from December 2013, when it was at 62.8%. This is the lowest it has been since March 1978. The number was at 66% in December 2007. What this means is that the rate of unemployment has been falling also because of people opting out of the workforce because they haven’t been able to find jobs and, hence, were no longer being counted as unemployed. So, things are nowhere as fine as broader numbers make them appear to be. The overall inflation also remains much lower than the Federal Reserve’s target of 2%. The Federal Reserve’s preferred measure of inflation is personal consumption expenditures(PCE) deflator, ex food and energy. For the month of February 2015, this number was at 1.4% much below the Fed’s target of 2%. The Fed’s forecast for inflation for 2015 is between 0.6% to 0.8%. At such low inflation levels, the interest rates cannot be raised. Yellen summarized the entire situation beautifully when she told the Senate Banking Committee earlier this month that: “Too many Americans remain unemployed or underemployed, wage growth is still sluggish, and inflation remains well below our longer-run objective.” What does not help is the weak durables data that has been coming in. Orders for durable goods or long-lasting manufactured goods from automobiles to aircrafts to machinery, fell by 1.4% in February 2015. The durables data have declined in three out of the last four months. Given this scenario, it is highly unlikely that the Yellen led Federal Reserve will start raising the federal funds rate any time soon. Further, as and when it does start raising rates, it will do so at a very slow pace. What this means is that the era of easy money will continue in the time to come. And given this, more acche din are about to come for the Sensex. Having said that, any escalation of conflict in the Middle East can briefly spoil this party. The article originally appeared on The Daily Reckoning on Mar 31, 2015