Is the stock market out of step with the economy?

Jun 01, 2021

Let’s start with a dose of reality.

India’s gross domestic product (GDP) has been falling over the years from 8.26% (2016-17), 7.04% (2017-18), 6.12% (2018-19), 4.18% (2019-20) and contracted by 7.3% in 2020-21.

Compared to a year ago, over 97% of India's population has become poorer compared to where they were in terms of income, and salaried jobs have fallen by 11-12 million: CMIE report.

The pandemic and its subsequent lockdowns has substantially increased informality in employment, leading to a decline in earnings for the majority of workers, and consequent increase in poverty in the country: Azim Premji University’s Centre for Sustainable Employment.

Yet, the stock market seems eerily detached from economic reality, and brazenly scales new highs. In May 2021, Vietnam and India were the Asia-Pacific’s top-performing markets.

I discuss this with Haresh Chawla, angel investor and partner at True North, who sees NO paradox. Here are his views.  

The listed firms are only a part of the formal economy; they are not the economy.

The listed firms grow bigger and more profitable at the cost of the informal economy (and smaller firms) So, while the overall economy shrinks, these firms grow.

Competitive intensity is lowered resulting in gains for larger firms. They now have more bargaining power. Suppliers and contractors get squeezed. Distributors put up advances. Due to work from home (WFH), the companies save on staff welfare expenses, pantry costs, electricity bills, travel, maybe even rent. Cost-cutting, WFH and rightsizing, and improved terms of trade all go to the bottom line directly. As a result, profit after tax (PAT) and cashflows are better than ever. According to Business Standard, the combined net profit of listed companies to GDP ratio hit a 10-year high of 2.63% in FY21.

All this in addition to a decline in cost of capital and a global flush of liquidity in the stock market.

That is why equity investors are richer on a relative basis.

Small/informal firms are facing tremendous hardship and bearing the brunt of an economy under lockdown. When they start running out of working capital, they begin to wind up.

This “Covid-Induced Redistribution" will set us back on human development indexes. But will remain hidden and be revealed only by the passage of time. Here’s why.

The Indian Family is a huge economic buffer. Indian families ride out catastrophes and calamities by coming together. An uncle gives a job, a cousin lends a hand, an aunt gives a loan.

Family gold pays the bills. Manappuram Finance’s gold loan auctions of Rs 404 crore to recover money is a sign of distress in the economy, as reported by Mint.

According to this report, households coped with the loss of income by reducing food intake, selling assets, and borrowing from friends, relatives and money-lenders.

For a large economy, as complex and layered as India, the aggregate GDP has multiple drivers. De-bottlenecking, productivity gains, foreign direct investment (FDI) inflows, and infrastructure investments will keep it chugging. We are already witnessing productivity gains unleashed by forced digitalisation due to the lockdowns.

But under the hood, the scene is more agonising. According to the Azim Premji University report, 230 million falling below the national minimum wage threshold of ₹375 per day during the pandemic, has increased the poverty rate by 15 percentage points in rural and nearly 20 percentage points in urban areas.

A family that was climbing up and into the middle class will now face a longer struggle. The dream has been pushed back by a few years. None of this will show up in the aggregate GDP.

Average per capita income is a distraction.

Per capita income is a measurement of the income earned per person in a country. It is an indicator of the standard of living in that country.

Average per capita income is the total income for the country divided by the number of people. It can be misleading as a few extremely wealthy people can raise the average.

Median per capita income is the point where half the people earn more, the other half earn less. It adjusts for these few extremely wealthy people.

What matters is median per capita income, which is far lower than the average per capital income. The economic repercussion of the lockdowns has driven that down.

Ironically, as the average improves, the median drops. The rich become richer. To keep our society healthy long term, we need to carry people along. We have to reverse this Covid driven inequality and keep a close watch on our Gini coefficient, which is a statistical measure of economic inequality in a population.

Going ahead…

The end of the pandemic or the market hitting a lifetime high does not signal that all is well. If we do not tackle unemployment, income distribution and competitiveness, this crisis will bite us down the road.

We are in danger of becoming a rich country with lots of poor people.

Re-skilling labour, vocational training, massive capital investments that create jobs, manufacturing incentives, easing the cost of doing business, rapid urbanisation, sectoral incentives that make the country competitive and allow labour force participation, are some of the measures the government needs to look at with a sense of urgency.

Haresh Chawla shared his views last year in The 5th largest economy needs to face reality.

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ninan joseph
Jun 5 2021 02:05 PM
Fully endorse with all the points mentioned by Haresh Chawla.

The unorganized sector is the worst effected, but then who cares about them. My in laws who never used to order groceries and other things online was forced to do the same due to the lockdown and now she says, she will continue to buy online as it is convenient. ITC I am told is starting its own online website. All this is a clear indication that the business mix is moving away from the unorganized sector to the organized sector.

With the kind of population India has, there will always be funds available with people. This coupled with low interest in bank deposits, and media awareness of inflation eating away their earnings people think MF is the way forward. One of my friend was asking my opinion on Covered Bonds, a new concept for me as well from Wint Wealth. This means, there is no lack of funds, and people are continuously looking out to make the extra rate. They just need a consolation that their funds are "Covered" by so called security. I informed him that if he is willing to take this level of risk, just buy HDFC or Reliance or any top notch company and leave it.
FII - When interest rate globally on bonds and FD is zero, where will all these funds go, they have to come to emerging markets.
Hence there will always be a disconnect between the real economy and the stock market.
Sanjay Bajaj
Jun 3 2021 04:27 PM
While there is no disputing his observations, I am given to believe that the GST measures like ITC credit mapping, e-invoicing and GST crackdown on fake invoices has resulted in companies having to show their turnovers correctly. Also all the GST measures must have reduced the incidence of fake invoices being debited resulting in lower expenses and higher profits.
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