Bull market logic

On June 4, the Lok Sabha election results shocked the markets and jolted the ruling Bharatiya Janata Party. But the markets were perturbed for barely two hours. By noon, stocks started recovering and within a week surpassed the all-time high it had hit just before the election results. A month later, as the steady upward drift continued, the indices were much higher still, belying worries about a hobbled minority government. On the day the Union Budget was announced, the markets fell due to the imposition of higher taxes on capital gains. Investors took two days to digest the uninspiring Budget provisions. On the third day after the Budget, the indices charged up again, recording handsome gains. Internationally, wars are raging in Ukraine and West Asia, pushing up shipping costs and time. Domestically, worries include electoral setbacks for the ruling party, poor consumption, jobless growth, and high actual inflation, combined with extreme valuations in certain pockets of the economy. And yet, the markets are scaling news highs. What gives? With the benefit of hindsight, here are the set of factors fuelling the bull market.

Government spending: For the first five years, the Modi government tried many tricks but struggled to generate much economic growth. In September 2019, the government slashed corporate taxes in the belief businessmen will use the money saved to invest and expand. Grateful businessmen mostly held on to the savings, partly spending them on dividends and buybacks. They did not invest more and tax cuts failed to create jobs. During Covid-19, the government was forced to adopt reflationary tactics to keep the economy going, which boosted economic growth and led to higher stock prices. Higher growth, combined with high rates of goods and services tax (GST) and strict enforcement of GST rules, led to booming revenues for the government, giving it elbow room for a second gamble —massive capital expenditure on highways, expressways, railways, water works, energy, and defence. This kicked off huge growth for a large number of listed companies, many in the smallcap and midcap space, which is why these indices have done much better than the largecap stocks.
 

The government has not given up nudging companies to invest. First it brought back tax on dividends. Then, Budget 2024-25 announced investors would be taxed when a company buys back its shares, with the payout treated as dividend income and taxed in accordance with their income slabs. Until now, companies have had to pay a 20 per cent tax rate on share buybacks. The idea is to discourage firms giving back surplus money to investors; it wants them to spend on expansion and job creation.

Savings pattern: For decades capital-market evangelists have dreamt of shifting the middle-class from investing in safe but low-return bank deposits to higher-return stocks. For a variety of reasons this did not happen, mainly because India has not had a long secular bull run. The 2003-07 bull market was marred by two major crashes in 2004 and 2006. In 2008 an epic global crash, which lasted almost a year, killed any interest in stocks. The current bull run, which started in May 2020, has been punctuated by minor declines in mid-2022 and early 2023. It has drawn in more and more investors. After years of poor returns from all other asset classes, investors have finally embraced equities. In 2020, the number of demat accounts was 40 million. It has now jumped to 162 million, unleashing a massive flood of investment, which is reflected in soaring stock prices — but the rise is backed by strong earnings growth as well.

Liquidity: With government expenditure boosting growth and savings ready to be invested in stocks, liquidity has done the rest. Rising prosperity in urban and semi-urban pockets and increasing corruption (leaching off massive state spending) have led to higher liquidity. From the public-interest angle this has created a lopsided economy — a K-shaped one — as a few people do well and the majority does not. But the consequence has been a stock boom of epic proportions. Just as nothing can stand in the way of a river in full flow, a torrent of money coming from Indian investors either directly into stocks or indirectly via mutual funds has pushed markets to higher levels. Adding to liquidity are foreign investors. In four of the first five months of this year, foreign investors were big sellers, but they have changed tack and are now sailing with the wind.

The question is, will these factors remain in place and allow the bull run to continue indefinitely? It all depends on continued growth in government revenues. If it slows, lavish capex spending — the only engine that is driving most businesses and pushing the market upwards — will slow. Already GST revenue growth appears to be down to single digits, which is probably why the government has decided not to publish monthly data anymore. But investors are primarily betting on the Modi government. Prime Minister Narendra Modi gives the impression that it does not matter that he does not have an absolute majority now. He has retained the same team and is continuing with the same policies. This has worked well for the past three years. Investors find this comforting and hence expect the growth — and the bull market — to continue, never mind the pinpricks of higher taxes.

The writer is editor of www.moneylife.in and a  trustee of the Moneylife Foundation; @Moneylifers