The traditional signal for a market bubble, as the popular adage goes, is when your cab driver or barber discusses stocks. The top-down variation of this indicator must be when finance ministry mandarins talk about asset allocation and profit booking.
The Economic Survey 2024, tabled in Parliament by finance minister Nirmala Sitharaman on Monday, highlighted various drivers of the Indian economy and suggested policy measures to lift growth and safeguard economic resilience.
The report, authored by chief economic adviser V Anantha Nageswaran and his team, also noted the prevailing trends in the domestic capital markets.
While most macroeconomic reports, especially those prepared by government officials, tend to rival art films in boredom and monotony, this edition had three crucial cues for the discerning investor.
First, overvaluation.
Noting that the Indian capital markets have been one of the best-performing among emerging markets in FY24, the Economic Survey pointed out that India’s market capitalisation to GDP ratio has swelled from 77% in FY19 to 124% in FY24, far higher than that of other emerging market economies such as China and Brazil.
Where valuations stand
This, however, makes it essential to strike a note of caution.
“The market capitalisation to GDP ratio is not necessarily a sign of economic advancement or sophistication. Financial assets are claims on real goods and services. If equity market claims on the real economy are excessively high, it is a harbinger of market instability rather than market resilience,” the report said.
The market cap-to-GDP ratio is more popularly known as the Buffett Indicator in financial circles. Warren Buffett called the ratio “the best single measure of where valuations stand at any given moment.” A reading above 100% generally denotes that the market is overvalued relative to its GDP. (Of course, periods of overvaluation can last for years, but that is a topic for another time).
The second important message of the Economic Survey is portfolio diversification.
The survey said factors that facilitated the rush of investors into equity investing in the post-Covid period include seamless technological integration, government measures towards financial inclusion, rapid smartphone penetration, a rise of low-cost brokerages, the pursuit of generating income from alternative sources, and lower returns generated by traditional asset classes such as real estate and gold.
“However, retail investors have cashed in their gains in financial markets and been investing in real assets. It is smart portfolio diversification,” it said, offering a helpful nugget of advice in the middle of a raging bull market.
Dangers of derivatives
The third message to investors, and one that everyone from the finance minister to the Securities and Exchange Board of India chief is delivering on a regular basis these days, pertains to the dangers of derivatives.
The survey noted that derivatives trading holds the potential for outsized gains, thus catering to “humans’ gambling instincts and can augment income if profitable.”
However, derivatives trading is mostly a loss-making enterprise for retail investors, even globally.
“Raising investor awareness and continuous financial education is essential to warn them of the low or negative expected returns from derivatives trading. A significant stock correction could see losses that are more considerable for retail investors participating in capital markets through derivatives. Investors’ behavioural response would be to feel ‘cheated’ by unseen more considerable forces. They may not return to capital markets for a long time. That is a loss to them and the economy,” it added.
Citing the example of the 2008 global financial crisis, the report said “financialisation of economies has not ended well, even for advanced economies.”
“Developing countries face debilitating crises when financial market ‘innovations and growth run ahead of economic growth. The Asian crisis of 1997-98 set back the high-flying economies of the region for a long time,” it said.
Therefore, India needs to have an orderly and gradual evolution of the financial market.
“All stakeholders – market participants, market infrastructure institutions, regulators, and the Government must ensure that capital markets play their theoretically assigned role of directing savings to their most productive investments. It is not just in the national interest. It is an act of self-interest, too,” the Economic Survey said.
