Which way is the market heading?

Dr. Tamal Datta Chaudhuri
Dean and Professor Calcutta Business School

In recent months, there has been news about economic slowdown in India, slump in the auto and FMCG sectors, and downward revision in the growth rate for the year. Against this, the government has taken some steps like merging public sector banks, reduction in the corporate tax rates and announcing fresh set of disinvestments in PSUs. The stock market as a whole reacts to these announcements and reads the signals in its own myopic way. Merging of public sector banks has little to do with reviving the economic growth rate in the short run. Cutting corporate tax rates cannot boost private investment immediately, unless there is presence of unsatisfied demand in the market. Increased disinvestments is a method to plug the fiscal deficit, and can fund fresh public spending. The stock market needs something to cheer about, and reacts according to its own understanding. However, these are short term responses and can lead to speculative gains or losses. One cannot have a long term perspective by analyzing the short term responses of the market to policy initiatives.

Figure 1 presents the movement in NIFTY and India VIX over a 13 year period. There is a qualitative difference between the two movements. While NIFTY has a trend, VIX does not. VIX, a forward looking measure of market volatility, is mean reverting. If some economic growth is there, however small, given the allocation between financial assets, some money will flow into the stock market thereby increasing NIFTY. The price increase may not be across all sectors and companies, but increase in market capitalization has to be there. VIX, on the other hand, measures implied volatility, and is a spread over the mean. It is the trend in this that is disturbing. If we take the period 2010-2017, the trend has been downward. However, in spite of rise in NIFTY, from 2017 till date, the trend in VIX has been upward sloping. This signals increased uncertainty about the near term and surpasses the euphoria associated with increase in NIFTY.

The overall market index will rise with time, with varying growth rates, but does not provide information about the macroeconomic prospects of the economy. Staying put in the market for a long time will lead to better returns, but does not imply that the economy has done consistently well during the period. The increasing trend in VIX is a disturbing sign for now.