The interest rate hikes of 2022-2023, and recent warnings and actions from authorities to curtail excessive risky behaviours suggest so.
The S&P 500 index, representing the top 500 listed companies in the United States, is down 5.65 per cent since 16 July 2024, the day it made an all-time closing high of 5,667.20. The index is down 3.2 per cent in the last two trading sessions – August 1 and 2.
Meanwhile, August 1 was a rousing trading day for the Indian stock market as Sensex crossed 82,000 points and Nifty50 crossed 25,000 points for the first time. This feat comes just one month after these indices created headlines when Sensex crossed 80,000 points and Nifty50 crossed 24,000 points for the first time.
However, the Indian indices fell on August 2 (Friday), likely reacting to the fall in the US and other global indices the previous day.
We are in a stock market boom. The Nifty50 index has gained 28 per cent over the last year. It had gained at an annual rate of 20 per cent over the past five years.
Considering that prices have risen at a rapid rate for a long time (5 years is long enough), it is likely that market prices might be in a bubble territory too. That is concerning because, eventually, all bubbles burst causing a sharp fall in stock prices, whose immediate aftereffects include massive wealth destruction and dashing of investor confidence.
The repercussions would soon be felt in the broader economy in the form of bankruptcies, bailouts, job losses, capital outflow, and finally, reduced economic growth.
It was the low interest rates that prevailed from 2008 onwards, until 2022, that fuelled the current stock market boom. But the boom is most likely in its final phase and the bursting of the bubble it bred is not far off.
Several factors support this theory. Firstly, we are no longer in a low interest rates environment post the steep interest rate hikes of 2022-2023: interest rates in most major economies are above their long-term averages.
Secondly, during the final stages of a boom, there would be regular warnings from authorities concerning excesses and excessive risky behaviour in the markets, the purpose of which is to cause market participants to bring down their excessively risky behaviours.
There were few such warnings from authorities – RBI, SEBI, and finance ministry – in recent months. Starting from May 2024 onwards, authorities have expressed concern about froth in the midcap and smallcap stocks, rapid growth in the unsecured retail loans by NBFCs, increased bank lending to NBFCs, and a dangerously high level of retail participation in the derivatives segment of the stock market.
Past boom and bust experiences have clearly shown that warnings have always been ineffective in curtailing excessive risky behaviours of market participants. Only concrete actions from authorities are effective. However, authorities are reluctant to take those concrete steps to avoid the blame for spoiling the party befalling them. Therefore, such actions usually come belatedly when they are the only recourse.
Past booms and bursts have also shown that it is one of those restrictive or preventive actions from authorities that prick the bubble and end the boom leading to distress, panics, or crashes. The specific action that triggered the burst would later be identified as the catalyst. However, pinpointing the exact action that would turn out to be the catalyst, before the burst, is unpredictable. We know them only once the bubble has burst.
There was one such concrete action from the finance ministry, recently, when it doubled the securities transaction tax on derivatives trading in the July 2024 budget. Additionally, SEBI has come out with a consultation paper to restrict the excessive speculation in the derivatives segment by retail investors.
The paper proposes to increase the minimum size of index options contracts to ₹20 lakhs in the first phase, and later to ₹30 lakhs in six months, from ₹5 lakhs now. It also proposed that exchanges be allowed to launch weekly options contracts on one index only, unlike now when they can launch weekly options contracts on multiple indices. Other proposals include limiting the number of contracts of big brokers, and the number of strike prices on the expiry day.
A series of such actions to restrict excessive risky behaviours in markets should be expected from authorities going forward. One among them would likely be the catalyst that brings the current stock market boom to an end. Unfortunately, the catalyst and its significance could only be understood in hindsight.
AMN CAPITAL 