The market-cap-to-GDP ratio has declined swiftly – from 79 percent as of FY19 to 56 percent (FY20 GDP) – much below the long-term average of 75 percent
The market-cap-to-GDP ratio is currently at its lowest level since the global financial crisis of 2008-2009. The ratio, which is used to determine whether the overall market is undervalued or overvalued, suggests that it might be the right time to put in money, but experts beg to differ.
The market-cap-to-GDP ratio has declined swiftly – from 79 percent as of FY19 to 56 percent (FY20 GDP) – much below the long-term average of 75 percent and closer to levels last seen during FY09, according to a report by Motilal Oswal.
The ratio, which is also known as Warren Buffett indicator, compares the value of all stocks at an aggregate level to the value of the country's total output. A value above 100% indicates that the market is overvalued while a number close to 50% indicates that it is undervalued.
The lowest in the last two decades was 42 percent in FY04. However, the number of listed and traded companies back then were much lower vis-à-vis today. The ratio hit a peak of 149 percent in December 2007 during the 2003-08 bull run, the report added.
The numbers might give an impression that the stock market might be trading at cheap levels, but experts suggest that the ratio does not reflect the true picture of the economy as well as markets. The true market-cap-to-GDP ratio is slightly skewed.
The success and the applicability of the market-cap-to-GDP ratio is higher when the market-cap reflects a much larger share of the economic activity in the country, said the Motilal Oswal report.
India Inc. in the year 2019 saw robust investment momentum from private equity with total investment of $37 billion as compared to $36.16 billion in the year 2018 (as per a report by private company data tracker Venture Intelligence).
“The true market cap to GDP ratio is slightly skewed as the PE investments which came in large numbers have not been captured while considering market cap. In addition to this, if one assesses the impact of COVID -19 which would largely materialise going ahead, the growth is projected to contract by 3.20% in FY2020-21 (World Bank),” Umesh Mehta, Head of Research, Samco Securities told Moneycontrol.
“Therefore, though this ratio looks attractive but optically it is still on a higher side taking into account the PE investment and true GDP picture,” he said.
“Historically, and specifically in recent years we always had low Mcap to GDP ratio. During the COVID-19 market crashed to abysmal levels and Mcap to GDP went below 50 which reflected the stark undervaluation in the broader market,” Paras Bothra, President of Equity Research, Ashika Stock Broking told Moneycontrol.
“Though this is not the only indicator to gauge the market valuation. Also, this indicator itself got changed sharply with decelerating GDP growth and anemic earnings,” he said.
Is it a wealth-creating opportunity?
The Indian market after slipping into a bear market has bounced back by more than 30 percent from the lows. Given that the ratio is slightly skewed, market cap-to-GDP ratio may be near its long-term average or slightly below but it is currently absolutely not at low levels on a like to like comparison, suggest experts.
Whether the aggregate Mcap rise or fall, identifying individual sectors which have its own bull and bear phase with changing fundamentals needs to be closely studied, they say.
“Identifying companies and emerging leaders in it which are likely to benefit from the tailwind of a sector is a reliable way to make sustainable wealth,” says Bothra of Ashika Stock Broking.
“Whether the overall market is in a bear or a bull market, there will be sectors which are always having a bull or a bear phase of its own for reasons mentioned above. This is primarily going to be my focus area,” he said.
Taher Badshah, CIO – Equities, Invesco Mutual Fund in an interview with Moneycontrol said that in a post-COVID world, the new normal for India Inc. will likely involve dealing with a defensive consumer, cautious borrowing and lending practices, conservative capital investing by corporates, greater digital and online intervention and even higher dependence on state support for driving growth in the system.
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