There is bubble in stocks; two-way price movements likely from here: RBI
RBI annual report highlights: Indian economy not as hard hit as COVID first wave but uncertainties remain
Synopsis
The BSE Sensex hit a record high of 52,154 on February 15, which represented a 100.70 per cent surge over March 23, 2020 levels. The index is hovering at 51,000-odd levels in Thursday's trade.
NEW DELHI: RBI's annual report released on Thursday suggested that the rally in domestic stocks despite an estimated 8 per cent contraction in FY21 GDP poses the risk of a bubble.
In a study “Is the Bubble in Stock Markets Rational?”, RBI said the widening gap between stretched asset prices relative to prospects for recovery in real economic activity has emerged as a global policy concern, while suggesting the need to consider a calibrated unwinding of stimulus once the pandemic waves are flattened and the real economy is firmly on a recovery path.
The BSE Sensex hit a record high of 52,154 on February 15, which represented a 100.70 per cent surge over March 23, 2020 levels. The index is hovering at 51,000-odd levels in Thursday's trade.
“This order of asset price inflation in the context of the estimated 8 per cent contraction in GDP in 2020-21 poses the risk of a bubble," it said.
RBI said liquidity injected to support economic recovery can lead to unintended consequences in the form of inflationary asset prices and, thus, noted that liquidity support cannot be expected to remain unrestrained and indefinite.
The apex bank concluded that the markets are driven by money supply and FPI investments. Economic prospects also contribute to movement in the stock market, but the impact is relatively less compared with money supply and FPI, it said.
The conclusion was derived after regressing stock prices (Sensex) on money supply (M3, as a proxy of liquidity), the economic outlook (OECD composite lead indicator) and foreign portfolio investments in the secondary equity market from April 2005 to December 2020.
Regression analysis is used for the estimation of relationships between a dependent variable and one or more independent variables.
RBI said the rise in equity prices from 2016 to early 2020 was mainly supported by a drop in interest rates and equity risk premium (ERP), and to a lesser extent by the increase in forward earnings expectations.
An equity risk premium is a return an investor earns on stocks over the risk-free rate.
RBI said a spike in ERP on Covid-19 concerns initially contributed to equity prices declining sharply to compensate for increased risks.
"However, equity prices registered an impressive recovery, subsequently, aided by easing of ERP. Currently, dividend yields have fallen below their long-term trends. As such, two-way price movements are possible going forward, it said.
RBI said that even when considering expected earnings growth of the corporates, the stock prices cannot be explained by fundamentals alone.
In a study “Is the Bubble in Stock Markets Rational?”, RBI said the widening gap between stretched asset prices relative to prospects for recovery in real economic activity has emerged as a global policy concern, while suggesting the need to consider a calibrated unwinding of stimulus once the pandemic waves are flattened and the real economy is firmly on a recovery path.
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The BSE Sensex hit a record high of 52,154 on February 15, which represented a 100.70 per cent surge over March 23, 2020 levels. The index is hovering at 51,000-odd levels in Thursday's trade.
“This order of asset price inflation in the context of the estimated 8 per cent contraction in GDP in 2020-21 poses the risk of a bubble," it said.
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RBI said liquidity injected to support economic recovery can lead to unintended consequences in the form of inflationary asset prices and, thus, noted that liquidity support cannot be expected to remain unrestrained and indefinite.
The apex bank concluded that the markets are driven by money supply and FPI investments. Economic prospects also contribute to movement in the stock market, but the impact is relatively less compared with money supply and FPI, it said.
The conclusion was derived after regressing stock prices (Sensex) on money supply (M3, as a proxy of liquidity), the economic outlook (OECD composite lead indicator) and foreign portfolio investments in the secondary equity market from April 2005 to December 2020.
Regression analysis is used for the estimation of relationships between a dependent variable and one or more independent variables.
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RBI said the rise in equity prices from 2016 to early 2020 was mainly supported by a drop in interest rates and equity risk premium (ERP), and to a lesser extent by the increase in forward earnings expectations.
An equity risk premium is a return an investor earns on stocks over the risk-free rate.
RBI said a spike in ERP on Covid-19 concerns initially contributed to equity prices declining sharply to compensate for increased risks.
"However, equity prices registered an impressive recovery, subsequently, aided by easing of ERP. Currently, dividend yields have fallen below their long-term trends. As such, two-way price movements are possible going forward, it said.
RBI said that even when considering expected earnings growth of the corporates, the stock prices cannot be explained by fundamentals alone.
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