When the stock market is a one-way street

Not even the best minds in the trade can put a finger on what could go wrong in the stock market. And when. Today, they are overwhelmed by a story that is unfolding before them - a story that has no precedence, defies all they have learnt about valuations over the years, and is growing on a belief that is getting embedded in the collective psyche of more and more people that the market can only move one way.

Most cling on to the logic that there is no better bet than equities. Those with bigger stakes are driven by business interest, politics and the very compulsion to keep a story alive as long as the going is good. And why not? After all, they have been proved right so far. Indeed, the two most powerful men in the country were fairly accurate in their forecasts about the post-election stock market even when they fell short of their claims on the poll outcome.

The precise prophesies in the short run and a sustained rally are beginning to mask the widely-accepted trait that equity markets are cyclical - and not an incessant upward story. But is the cycle becoming longer and longer? Amid the rush of money chasing stocks, will a correction take longer than it took in the past? Perhaps yes. Almost subconsciously, the world has taken for granted the liquidity that is buoying stocks.

Since 2009, there is an unmistakable positive correlation between expansion of balance-sheets of central banks and leading equity indices. Central banks, anxious to salvage their image following the meltdown, inundated the world with money to keep afloat bankrupt sovereigns and tottering economies. In the wake of the pandemic, the story played out again.

But, since then, monetary authorities, particularly of the advanced economies, have been slow in pulling back the money they had released. A lurking fear of financial instability, uncertainty and job losses have held them back from restoring the pre-crises monetary normalcy.

Nurturing the sentiment became a priority, and many central banks and governments worked together to maintain economies on an even keel. Somewhere along the way, the equity indices emerged as a key barometer of economic well-being.

As the big boys bumbled along to save the world, preconditions were created for a change in behaviour of ordinary people. The sharp cut in interest rates, money sloshing around across markets and the bounce-back of growth and equities post-Covid have had an unprecedented demonstration effect on people who are dazzled by the money that others made by simply staying invested and pouring more funds into stocks.

The pendulum has swung to the end: from the days where the stock market was an opaque satta bazaar, it now commands a new trust.

Not that there are no reasons to question the flows into equities. Net financial savings are down, consumption growth has slowed, interest rates are supposedly at the peak and central banks are buying gold like never before to cushion shocks from possible geopolitical tremors. Most of the spending, be it in the US or India, has been done by the government as capex or doles to boost investments or consumption. Many of these traditional drivers that would have dampened sentiments before, exist today. But a market, backed by liquidity, is unfazed.

In fact, there's a volley of counter-questions that one runs into: why would the market fall? Who will sell? Even if they sell, where would they reinvest the money? Aren't new investments into MFs and SIPs more than what is stopped?

All true. Neither promoters of listed companies nor the government are selling in a way that would release fresh supply of stocks to stem the prices.

Even some of proverbial swords - such as a possible hike in short-term capital gains tax, a higher securities transaction tax (STT) on stock derivative trades, or an end to offsetting derivative gains against losses - may not be sharp enough to slay the spirit. A surge in return on risk-free assets like bank deposits, plunge in growth (where the economy really performs badly), or an external shock like the pandemic can significantly slow down stock investments.

However, keeping aside the third possibility - an 'unknown-unknown' - there are slim chances of the first two happening: interest rates could soften next year, while the economy is unlikely to do terribly as growth tends to be higher in countries with lower per-capita income. And, only a few think regulators would splash cold water. Investors chasing past returns are holding on to such theoretical strands.

In the matrix of 'earnings', 'sentiment' and 'liquidity' - the last two intact as of now - could be preserved if the first behaves. Even a less-than-expected growth of some sectors may not immediately cast a shadow on Sensex or Nifty if their weight in the indices is comparatively low.

Fund managers, who have to deploy the money coming in, are probably starting to feel it in their bones the dilemma of what stocks to buy, at what prices. Unlike their sales and marketing colleagues marshalling inflows, they may be trying to figure out what can go wrong as more households, in a still under-penetrated market, are allured by the hugely successful catchline, 'Mutual funds sahi hai'.