Indian equities have been on a tear despite there being no visible improvement in macro-economic indicators and corporate earnings growth. The 30-share Sensex is up 23% since the start of this calendar, defying worsening industrial output, slowing GDP, out-of-control inflation, widening fiscal deficit and a growing subsidy bill. Foreign institutional investors have already pumped in around USD 16 billion so far this year, even as a sovereign rating downgrade looms large. So what could explain the craze for stocks in such a depressing environment? Most importantly, should you be buying shares when the economy seems to be headed downhill? Brokerage house Morgan Stanley tries to find the method to the madness:
(Excerpts from Morgan Stanley's strategy note)
Bad macro does not mean bad earnings and vice-versa
Of course, GDP growth is crucial to corporate fundamentals. However, a high GDP growth does not mean high profit growth and vice versa. Our work shows limited correlation between these variables.
Positioning and sentiment among other factors play a role
Share prices are a function of earnings growth (or more accurately dividend growth in the long run). However, over a 12 month time frame, even valuations do not fully explain share price performance. Share prices care for earnings growth, liquidity, sentiment, ownership, flows, valuations and a host of other independent variables.
What's priced in is crucial to market behaviour
Chances are that if shares are cheap and sentiment is poor (another way of saying expectations are low), share prices could rise even when macro is weak.
Markets can be and are relative
In the context of global markets, the relative growth of a certain economy could also help markets, i.e, India could just be the good house in a bad neighborhood, and this could help share prices rise.
Markets are concerned about delta
While the macro focuses on the absolute level, the market responds to the change at the margin. So the macro can be bad, but if it is getting less bad at the margin, markets could run ahead.
Markets can be influenced by dispersion
Portfolios are not made by buying GDP-they are made by buying stocks. Even when headline growth is weak, major index components can deliver idiosyncratic performance which matters to index returns