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MOSL: ECOSCOPE-Explaining the divergence between the economy / equity markets

ECOSCOPE: Explaining the divergence between the economy / equity markets; Differentiating the listed companies’ performance from the rest of the economy

 

• It is now commonplace to highlight the divergent trends between the record-high equity markets and declining to marginal growth in economic activity. In this note, we argue that such divergent trends should not be surprising, considering that the former is entirely linked with the performance of listed companies, while the latter has a much broader scope.
• The strong performance of the equity market is a reflection of the fact that the gross value-added¹ (GVA) of the listed non-financial companies² (NFCs) grew ~14% YoY in 2HCY20 and 36% YoY in 1QCY21. The GVA of the rest of the economy (RoE), however, shrank ~2% YoY in 2HCY20 and grew 6.7% (slower than the pre-COVID trend) in 1QCY21.
• The Corporate sector (Financial + Non-Financial) in India accounts for about 45% of the national GVA (vis-à-vis ~75% in the US). However, the GVA of listed NFCs is just a fifth of the entire corporate sector. This implies that the GVA of listed NFCs accounts for less than 10% of the national GVA. Furthermore, fixed asset investments by listed NFCs are also less than 10% of the total investments in the economy, while their share is just ~3% of the total non-farm employment in the country.
• The two very important inter-linked questions to ask, then, are “Why have listed companies done so much better?” and “Will the better financials of listed companies pull up the rest of the economy?” The objective of companies is to maximize shareholders’ value, which is achieved by generating maximum profits. As we have discussed in detail, corporate profitability could improve owing to either (a) better economic growth (led by investments) and/or (b) other factors such as higher fiscal deficit, lower household savings, and/or better current account balance. As listed NFCs have lowered their investments, it is clear that higher corporate profitability is being driven by other factors.