Equity Markets have been rallying continuously for the last 4 months. NIFTY 50 has gained 67.30% since the recent low in March 2020. COVID-19 has had an adverse impact on the global economy. In the Indian context, there has been a substantial decrease in the growth rate. The last few months have seen the equity market move towards a ‘bubble formation’.
“Everybody is a genius in a bull market” — Mark Cuban
What is a bubble?
A bubble is an economic cycle driven by sentiments leading to the rapid growth of index valuation, followed by a sudden downfall. Due to the increase in prices, investors refrain from parking their money in the equity market. This results in a huge sell-off causing the bubble to deflate. This increase in index valuation is dependent on various factors.
What might be the possible factors fuelling the rally?
● High Liquidity:- A sudden halt experienced in business activities generated unemployed capital. Businesspersons diverted this unused cash in hand towards equity markets resulting in an increase in demand. They viewed the continuous extensions of the lockdown as a financially gainful opportunity and thus increased investment in the equity markets. Banks were directed to increase liquidity in the economy as well.
● New Investors:- The interruption of the activities of the tertiary sector and academic institutions created a new group of investors. College students, working professionals and business persons alike started investing vigorously in a not-so-risk-free equity market. DEMAT account openings witnessed a sudden rise of 22.9% in the current year. In India,
the number of DEMATs accounts has now rallied to 4.9 million. New to the scenario, these investors who have little to no knowledge of stock market operations, blindly followed the bull-run and contributed to the rally.
● Global Sentiments:- Indian markets have always closely followed the American markets. The Federal Bank of USA has been keen on increasing liquidity in the American economy. Resultantly, NASDAQ and DJIA have reached record highs. Indian markets have been following the path and now witnessing a continuous rally like their American counterpart.
● The hope of reopening:- In the initial stages of the imposition of the lockdown, it was forecasted that development would impede for 6-8 months. Panic selling caused equity markets to go haywire. Duly, the indices hit two lower circuits in a single week and wiped out almost Rs. 14.22 Lakh Crore from the equity markets. Remarkably, the economy started getting back on track within a couple of months and the businesses started functioning. Therefore, the equity market went on to correct itself and retraced almost 67.30%.
Despite these positive sentimental events, the market is fundamentally weak and might run into correcting itself soon, causing a fall.
When can the fall come?
The ‘Dot Com’ bubble lasted for almost 5 years from 1995 to 2000 which indicates the unpredictable time frame of the crash. Likewise, the stock market might take more than a few days before correcting itself, especially due to the recent vaccine development speculations and hopes of economic recovery.
What could lead to the fall?
- Trade War:- China and U.S. are in the midst of a trade face-off. The two superpowers have been in a tussle for a while and any further sanctions might lead to a global breakdown.
- Failure in Vaccine Development:- One of the major reasons for the rally in the equity markets was based on hopes of early vaccine development for COVID-19. If the major companies like Pfizer fail do develop the vaccine, a huge sell-off may occur leading to a crash.
- Indo-China Clash:- NIFTY 50 had shed almost 150 points in 20 minutes on 16/06/2020 when the news about border tensions between India and China first broke out. This indicated how equity markets reacted to such news. While the situation is stable now, any further actions on this front by either government may break the equity market.
- Lockdown:- Indian economy has managed to survive the previous national lockdown and the subsequent extensions. Now, the government is posed with the choice of choosing between saving its people or saving the economy. Although a complete lockdown might be required to stop the spread of the virus, further extensions might break the backbone of the Indian economy, potentially leading to a huge crash.
Indicators of Reversal
- Fibonacci Retracement shows that the markets might reverse from 11,382 and might go down to 10800, 10350 and might even break to 9900 levels. The markets have already corrected more than 67% and a reversal is on cards.
- Fundamentals suggest a huge turn around in the markets. With Q1 earnings release round the corner, sentiments can weaken which could be devastating for the markets.
- Shiller PE Ratio The cyclically adjusted price-to-earnings ratio, commonly known as CAPE, Shiller P/E, or P/E 10 ratio, is a valuation measure usually applied to the Indices. It is defined as price divided by the average of ten years of earnings, adjusted for inflation.
|Event||Shiller PE Ratio||Downfall|
|The Greatest Crash 1929||30||24.8%|
|Dot com Bubble||43||78% down from the peak|
|21st August 2020||30||?|
In the coming quarters, there is a risk of GDP growth rate in India taking a negative turn. The sentiments will be conclusive in shaping the equity markets. In addition, vaccine development, economic recovery and global cues might well decide the course of the markets.
Technical and fundamental analysis of the Indices indicates a potential reversal. Buyers must remain cautious now.
The indices usually correct themselves abruptly. In such cases, blind investors often get trapped. Consequently, any investment should be made cautiously and any directional trades should be hedged appropriately.