The "Demonetisation" Stock Market Rally is Clearly in Bubbly Territory Now - Vivek Kaul's Diary
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The "Demonetisation" Stock Market Rally is Clearly in Bubbly Territory Now

Nov 28, 2017


"This time is different," is an argument that is often heard whenever an asset class is selling at peak valuations. And this is the argument that is now being made when the Indian stock market is at extremely high valuations.

Take the case of the Nifty, an index of 50 stocks listed on the National Stock Exchange. As of November 27, 2017, the index had a price to earnings ratio of 26.61. In simple English, this basically means that an investor is right now ready to pay Rs 26.61 as a price for Rs 1 of earnings for the stocks that comprise the Nifty.

The last time the stock market saw a similar price to earnings ratio was in December 2007 and January 2008, when it was at its peak, and after which it crashed. The only time the stock market has sold at a higher valuation than now is February 2000, when the price to earnings ratio of the Nifty was 27.12. This was when what came to be known as the Ketan Parekh scam was at its peak.

Let's take a look at Figure 1, which plots the price to earnings ratio of the Nifty stocks, over the last one year.

Figure 1:

What does Figure 1 tell us? It tells us that the price of the stocks that comprise the Nifty has gone up much faster than their earnings. This basically means that what the stock market junta likes to call valuations, are in high territory.

This, is not to say, that the stock market is ready to crash now. That is something, which, as always remains difficult to predict. As John Maynard Keynes, who had a quote for almost every occasion, said: "Markets can remain irrational longer than you can remain solvent".

But what can be said for sure is that markets are clearly in bubbly territory. Given the earnings per share of stocks, their current prices cannot be justified. Let's look at more data in Table 1.

Table 1: Aggregate performance (all companies)

Table 1 basically gives the details of the growth in sales and profits for 1,241 companies, for the period July to September 2017, the last period of three months for which financial results are currently available. The sales of these companies went up 7 per cent during the quarter, against 10 per cent during the same period last year. The profits were down 1.5 per cent, against the 7 per cent increase during the same period last year.

Let's now take a look at Table 2, which excludes banks, information technology companies, oil and refinery companies and finance companies. This includes 920 companies.

Table 2: Industry performance - Excluding banks, IT, oil & refineries and Finance (%)

In this case the profits are down 4.4 per cent. The sales are up by only 4.7 per cent. In fact, the situation becomes even more tricky when we look at companies with quarterly sales of greater than Rs 1,000 crore and which form over 70 per cent of the sales. In this case, the net profit fell by 7.4 per cent between July to September 2017. It had risen by 10.9 per cent between July to September 2016.

The current leg of the stock market rally started post demonetisation. The Nifty has returned 25.4 per cent between November 7, 2016 and November 27, 2017. This is a humongous return for a period of a little over one year.

Take a look at Figure 2, which basically plots the Nifty index values over the last two years.

Figure 2:

Figure 2 clearly shows that the current stock market rally started after demonetisation was announced by prime minister Narendra Modi on November 8, 2017.

This is precisely why the stock market investors love demonetisation. I recently spoke at an investor conference and some of the reasons I heard in defence of demonetisation were hilarious (we will leave that for another day). In fact, one gentleman, explained his theory on demonetisation to me, and when I took a moment to react, he just turned around and walked away.

As Jean Tirole writes in Economics for the Common Good: "The way we form and revise our beliefs serves to confirm the image we want to have, both of ourselves and of the world around us." It seems that this gentleman along with many others who I happened to meet had paid a bomb to basically get a reconfirmation of things that they already believed in from the speakers at the conference, rather than listen to new ideas. But as I said earlier, we will leave that for another day.

Now getting back to the topic at hand. One of the stories that has been sold in favour of stock market investing over the last one year, goes somewhat like this. Demonetisation has hurt the informal part of the economy very badly. This means that the formal firms (with many of them listed on the stock market) will take over the informal economy and thus grow in size. This will obviously mean higher profits than before, and which is why you should invest in stocks. The data clearly shows nothing like that has happened. But the story is still going strong and is at the heart of the "this time is different" argument that is being currently made.

In fact, the fund managers, whose compensation actually depends on how well the stock market does, are the heart of keeping this story alive. The trouble is what is in their interest is not in the interest of the investors at large. The incentives are misaligned. And honestly, rare is a fund manager who has used high valuation as a reason not to take in more money in the fund that he manages. In that sense, demonetisation, like quantitative easing that happened in Western countries in 2008-2009 has helped the rich, given that it is the rich in India, like everywhere else, who invest in the stock market. Quantitative easing essentially refers to steps that central banks took by printing money and pumping that into the financial system to drive down interest rates, in the hope of getting both people and companies to spend more. While that may have been the idea, a lot of this money found its way into financial speculation all across the world.

As Stephen D King writes in Grave New World-The End of Globalization, The Return of History: "[The rich] proved to be major beneficiaries of quantitative easing... The S&P 500 index peaked before the global financial crisis of 1,557. It then plummeted to a low of 683. A handful of years later - partly a response to the sustained pump-priming from the Federal Reserve - the index had jumped to a new high of 2,270. Given that around 90 per cent of the total value of financial assets in the US is owned by the top 10 per cent of households, this was - particularly for the very well-off, a very pleasant windfall gain."

Something similar happened in India in the aftermath of demonetisation as well. Banks interest rates fell dramatically forcing many people to divert their savings into the stock market. Over and above that, many trade businesses which largely ran on cash, were destroyed. A lot of this capital has also found its way into the stock market.

And given this, not surprisingly, the stock market rallied. The rally brought in more investors and the stocks rallied even more. Hence, it is not surprising, that the rich who had money invested in the stock market, remain one of the biggest supporters of demonetisation. They are the ones who benefitted the most from it. And how can something from which you have made money, possibly be a bad thing?

Vivek Kaul is the Editor of the Diary. He is the author of the Easy Money trilogy. The books were bestsellers on Amazon. His latest book is India's Big Government - The Intrusive State and How It is Hurting Us.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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11 Responses to "The "Demonetisation" Stock Market Rally is Clearly in Bubbly Territory Now"

surajit som

Dec 1, 2017

Most people are obsessed with Nifty fifty. Just like they are obsessed with dynasties and their bogus scions. What about the rest of NSE/BSE stocks ? In BSE, there are nearly 5000 stocks. In USA ,you have S & P 500. Here in India we are obsessed with 30/50 stocks. I would request Shri Kaul to take at least 500 stocks.I am sure the outcome will be interesting. What about huge churning in NSE ? Most imortantly, young generation is taking to equity for investment, not apartment ,gold etc. Besides , now Markets world over are in bubble territory . NSE/BSE can not function in isolation. What about that ? In US, MC divided by GDP is nearly 150 %. In India ,it is below 100 % which is not excessive. Shri Kaul, any comment ?

Like (1)


Nov 29, 2017

So you have found a new class of people who support demonetization. Rich stock market investors! Because they are getting richer due to the current rally. What about the other class who blindly opposes demonetization at every opportunity? Lets see what their reason is? If someone had a pile of black money under his bed and it all became worthless in a single night, what would be his reaction? By the same logic of yours how can something, due to which you lost money, be a good thing? Sir, this sword of yours cuts both ways.

Lets wait and see if demonetization was a success or failure, time will prove that. Till then please do not bring up this 'fighting for poor' image because you know very well that nobody, including yourself, is fighting this for them.

Like (1)

Bimal Joseph

Nov 28, 2017

It is still too early to say that demonetisation had no positive effect on the formal economy. I do not think that such massive changes can be captured in just a few months data.

Rich people always made money from stock market at the expense of retail investors. If the market crashes they would still be rich and the small investors will lose money. Demonetisation causing a stock market rally and making rich people richer is a lousy view. The market will correct, that is certain. What that will prove about demonetisation? Yes, you can say "I said so" with hundreds of other doomsayers in the line now.

Like (1)

R Tayal

Nov 28, 2017

Good analysis. Agree, markets have a propensity to discount the egregious news sometimes way ahead of time.
Also agree to your comments on the gentleman who almost got offended by your alternative view, comforting himself with confirmation bias. But charity must begin at home, and therefore the economist extra-ordinaire Vivek must also pause to think whether he has also been afflicted by the same phenomenon in his analyses lately (not referring to the current article).

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Nov 28, 2017

Your columns are becoming a laughing stock with each passing day since your article on Demon in Demonetisation.Its high time Sir , you start accepting that Demonetisation has been a progressive step ever taken by any Government in the past.Even the International Rating agencies have gone on record stating the benefits that would accrue to the economy on account of this bold decision of the Government. Now that the economy is on the verge of growth trajectory which is gradually being reflected in the Stock markets, you have now found a new punching bag in the Mutual Fund advisors.Only time will prove how your theories have been wrong on the issue of Demonetisation.Markets will rise and Markets will fall, Demonetisation or No Demonetisation.Sir, It makes no sense at ridiculing the MF advisors.

Like (1)

bhushan oke

Nov 28, 2017

Dear Vivek,

I've been a member of Equitymaster for a few years now and have been reading all your articles. What I admire most about your writing is that you take pains to dog out and interpret data to support what you write. Your articles about judicial overreach, IPL water supply issue, Sugarcane crop exploiting India's precious resource (Water) etc. to name a few.

In this instance however you may have missed a point about how it is different this time and you may well be able to prove or disprove this with data. Indian stock markets in the past have been heavily affected by inflow or outflow of FII capital in the markets. FII money has been driving the bull and bear runs every year so far. However this year the DII (Read mutual funds and retail investors) have been pouring money in stock markets in hope for great gains and not to miss India growth story. The exit by FII money has been cushioned by DII and retail and markets are continuing on the up. It is the retails investor money that is driving the markets through MFs and direct investment. Unfortunately the MFs are forced to buy when they get subscriptions despite tough valuations and retail investors follow the trend. These new investors don't know much about valuations and earnings and therefore are oblivious of the risks. If the markets fall, they might lose nerve and leading to exit of big local money.
Be that as it may, it is definitely different from this viewpoint and I would request you to look in to with with your seasoned lens.


Like (1)

Sabyasachi Sadhu

Nov 28, 2017

This charlatan named Vivek Kaul is a congressi henchman, so he gives biased info for his italian master. I laughed out loud when this charlatan says he was invited for speech, who in this world will invite you moron to discuss about economy??

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Nov 28, 2017

Vivek Kaul concludes that it is the rich who favoured demonetization; therefore they invested heavily in the stock markets which have boomed ever since 8th November 2016. This is the exact contra to the story one reads about how the rich who had hoarded black money rushed to deposit this unaccounted cash into their bank accounts (besides using those of their confidantes) hoping to "legalize" it. If this cash pile was used to drive up stock prices, then these folks will have to explain the tax man (already snapping at their heels) on the source of this cash. Which, theoretically, could lead to a sudden sell off of shares to pay taxes and penalties. But, politically demo has been a winner for Modi as the poor are convinced this step has hurt the rich more. Kaul underestimates the impact on the stock market of the political stability brought about by Modi. Net net, demo per-se is not the root cause for the boom in the stock market. Political stability is the real factor behind this boom.

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Nov 28, 2017

A plausible explanation that I have heard is that Pension funds must now invest in stock markets as per government directives and these are long term investments and perhaps this explains the current boom in stock markets.

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Nov 28, 2017

You have aroused our interest in what people told you about demonetisation. Waiting eagerly for that !

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