Nifty50 and Sensex are ruling close to their peaks. While Nifty has generated returns of 12.2% year to date, Sensex has given 9.4% returns.
From the bottom in March 2020, after the pandemic hit, both the indices have generated returns in excess of 100%.
The market capitalization of Indian stocks has crossed the $3-trillion mark, making us the world’s 8th largest. The market cap to GDP ratio has also crossed 100%.
A decline in coronavirus cases, recoveries exceeding new additions, a roadmap for vaccination for all by the year end, US Fed’s indication of continuing with its bond purchase programme despite concerns of inflation have provided a fillip to the markets recently.
The Reserve Bank of India’s accommodative stance and better than expected Q4 FY 20-21 GDP growth numbers is also fuelling the markets.
However, all is not hunky dory as markets indicate. Agencies have cut GDP forecasts for FY 21-22 to below 10%, the unemployment rate reached highs not seen since June 2020, around 1 crore people have lost jobs in the second wave.
More than 1.5 lakh people have lost their lives to the pandemic, 97% households have gotten poorer compared to last year, wholesale inflation crossed 10% and the Purchasing Managers' Index (PMI) fell to 50.8 in May.
Are the stock markets showing signs of a bubble?
The Reserve Bank of India has ignited this debate with its comments in its Annual Report for FY 20-21.
According to the RBI, prices of risky assets have surged across many countries and have touched record high levels during 2020-21 on the back of unparalleled levels of monetary and fiscal stimulus.
The central bank said the turn in market sentiments ‘following positive news on the development of and access to vaccines and the end of uncertainty surrounding US election results’ were some of the major factors that led to increased valuation of global equities.
“The widening gap between stretched asset prices relative to prospects for recovery in real economic activity, however, emerged as a global policy concern.” It added,
“This order of asset price inflation in the context of the estimated 8 percent contraction in GDP in 2020-21 poses the risk of a bubble.”
It concludes by saying, “...currently, dividend yields have fallen below their long-term trends. As such, two-way price movements are possible going forward.”
What is a bubble?
As per Investopedia, “A bubble generally refers to a situation where the price for something—an individual stock, a financial asset, or even an entire sector, market, or asset class—exceeds its fundamental value by a large margin.”
Because speculative demand, rather than intrinsic worth, fuels the inflated prices, the bubble eventually but inevitably pops, and massive sell-offs cause prices to decline, often quite dramatically.
In most cases, in fact, a speculative bubble is followed by a spectacular crash in the securities in question.
Are we in a bubble?
The markets have had a phenomenal run since the crash in March 2020 last year with returns of more than 100%. This has given credence to the theory that markets are overheated, a bubble is around the corner and a big crash is imminent.
Following indicators show we aren’t in a bubble
1) The starting point should be Feb 2020 and not March lows. Sensex was at 41,000 levels in Feb 2020, just before coronavirus hit India. From there, markets have risen by less than 30%.
2) In earlier bubbles, markets have gone up 2-3 times from lows, currently only by 100%.
3) The ratio during the beginning of the dot com (2000) and 2008 bubble, was 1.03 and 1.07 respectively. At the peak, this ratio was trading at 2.10 and 2.0 respectively after which it started to fall. Currently this ratio is at 1.2.
4) Most of the previous bubbles have had a central theme. In the 1990s it was NBFC, in 2000 it was IT, in 2008 it was infrastructure companies.
The breadth this time in the market is more board based. IT, Bank, Realty, Commodity and Metal sectoral indices have risen by more than 75% in the last one year.
5) Another prerequisite of a bubble is leverage. Highly leveraged positions of traders have been responsible for taking the markets higher and then falling like a pack of cards.
Following indicators show bubble may be round the corner
To sum up, most ratios and indicators show that the market is not in a bubble yet.