View: Growth of real economy is the gentlest way off the capital market rollercoaster

View: Growth of real economy is the gentlest way off the capital market rollercoaster

India’s stock market benchmarks, Sensex and Nifty, today crossed 50,000 and 14,700, respectively. Some will pop bottles of champagne, while others worry where they will find themselves when the bubble eventually bursts. The price-to-earnings ratio for the Sensex is 34.42, meaning that to gain command over Re 1 of earnings, you need to buy stock worth Rs 34.42. That is steep, by any yardstick. And the price to book ratio is 3.39. It is not unnatural for companies to be valued in excess of their book value. But this valuation, too, seems indulgent. Should investors stay put and celebrate or sober up and exit? It depends on their appetite for risk.

Greed and panic drive the markets, it used to be said. Add central bank liquidity as a new driver of capital markets around the world. In response to the pandemic and the economic downturn it brought on, governments around the world offered their citizens support worth $12 trillion, says the International Monetary Fund. A portion of that leaches into the pool of capital scouring the world for profitable deployment. The monetary creation was accompanied by lowering interest rates to record lows. The 10-year US treasuries yield 1.08 per cent. Policy rates are negative in Europe and Japan. Diversifying portfolios across asset classes is the way to optimise risk and reward. So, a good part of the footloose capital comes to emerging markets. India got $23 billion of portfolio flows into equity in 2020, even after the panic outflows in March and September. In January so far, more than $3 billion has come in. Domestic investors, too, have been investing in stocks in unprecedented numbers, given the low returns on traditional saving instruments such as fixed deposits.

The US Federal Reserve wants to keep money easy till inflation stays put above 2 per cent for some time. So, markets could keep their heady levels and even grow. The ideal way off the rollercoaster is for the real economy to grow to justify the valuations. Growth should be the focus of policy.

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