What Are Bubbles?
Bubbles are market phenomena characterized by steady escalation of prices of assets and subsequent quick deflation, referred to as ‘crash’ or ‘bubble burst’. Some examples of bubbles are the ‘Dotcom Bubble’ of the late 1990s associated with tech stocks and ‘The 2008 Housing Bubble’ relating to US real estate assets. Right now, the Indian Stock Market is on a bull run, with Sensex at an all-time high of 59000 points. India’s Nifty50 Index has more than doubled from March 2020 lows and is achieving new peaks every month. In the wake of unprecedented growth of Stock market prices, RBI(Reserve Bank of India) has warned Investors of an imminent Bubble formation as prices of risky assets have surged in the past six months. As the Bubble grows, piling pressure on the Stock market, investors are worried that it may burst and cause widespread havoc similar to the 2008 Global Financial Crisis.
Is This a Bubble?
The rapid gains are believed to be the effects of unmatched Fiscal and Monetary Stimulus provided by the RBI and the Government to ensure liquidity in markets and bring the downtrodden economy back on track. The general perception of mass vaccination and negligence of a possible third wave of Covid has instilled a sense of security in Investors leading to invest more in stocks. Additionally, High levels of Foreign Direct Investment flows have also contributed to greater liquidity and in turn rise in share market prices in the country. During the pandemic, stock markets witnessed large numbers of new entrants in the economy due to raising financial literacy and the growth of stock trading apps like Groww and Demat. In 2019-20, on average, 4 lakh new Demat accounts were opened, which surged to 26 lakh per month in the current financial year. The RBI is concerned about the widening gap between the prices of assets and prospects of economic recovery. The combination of an 8 percent contraction in GDP with unprecedented asset price inflation poses as an ingredient to a building bubble. It also hints about the overvaluation of assets beyond their intrinsic value.
Why are People Afraid?
Retail Investors are worried about the fear of shares plummeting, leading to a loss in investments. Securities and Exchanges Board of India(SEBI) chairman Ajay Tyagi has recently cautioned investors against market risks and make conscious decisions and not get carried away with market frenzy. Retail Investors may get tempted to transfer funds from fixed deposits, gold, and provident funds to equities in the share market. He has advised investors to diversify assets as different assets perform differently at different times, and a diversified portfolio can survive an imminent bubble burst better than a nuclear portfolio with overpriced stocks. Experts have also stressed the need to safeguard cash in an asset class like Gold or Real Estate, which preserves the capital and is less vulnerable to market crashes compared to high return equities.
Excess liquidity in the market, the prime cause of the steep increase in asset prices will be controlled by central banks. When it happens, the first sign of price drop will be visible, and investors will frantically try to sell their stock, and the market may crash. Nobody can predict the inflection point of the Indian market as it involves many uncertain cards depending upon each other. Michael Burry predicted the US Housing Bubble in 2005, but he could not predict when exactly the market will crash. The US market crashed 3 years later causing the 2008 Financial Crisis. SEBI speculates that the market may start to spiral down at the end of this year, but its effects will not be as severe as the stock market plunge in March 2020 due to Covid. Needless to say, Central Financial Institutions should withdraw liquidity from Markets in a systematic manner so as to save the economy from another catastrophe.