2020, a year that will go down in history as probably one of the worst mankind has ever faced. Granted, there have been many catastrophic events across the centuries - world wars, plagues, financial depressions, yet their rarely has been an event that brought the whole world to a literal standstill in an age where labour, commerce and capital move as freely as the wind. Hence, it made sense to predict that the financial markets (which are looked upon as a proxy for the economy) would crash beyond our wildest expectations. And crash they did in March 2020. Early commentators assumed it would take years, if not decades, for the economy to bounce back and the financial markets along with it. People spoke about a “U” shaped recovery, a “W” shaped recovery and even a “Nike swoosh” shaped recovery.

Boy, were we wrong! It so happened, that the financial markets made the quickest “V” shaped recovery against all odds, even though the economy teetered. And the recovery was well received across the world.

The US S&P500 in Feb 2021 had already exceeded the pre-COVID level by 16%. Indian markets rallied too, with the benchmark NIFTY50 crossing 15000 levels, up 100% compared to 7500 levels at the peak of the crisis.

Moreover, this asset price rise was not backed by actual economic recovery. The S&P500 PE ratio (a measure of value to underlying earnings) stood at 40x in Feb 2021 almost twice its median of 21.8x and the highest in the last decade following the 2008 financial crisis. The NIFTY50 PE ratio followed suit standing at 41.6x vis-a-vis median of 20.3x, the highest ever recorded.

So, how can this buoyancy be explained in a year of mass human suffering?

The short answer – artificial liquidity.

A couple of things that led to this:

1.   Money became cheap

In Feb & Mar 2020, just when the world started taking COVID-19 seriously, economists around the world fret over the global health crisis morphing into a global economic crisis. Amidst various lockdowns, the central banks took swift action in introducing policies to bolster economic activity. In this regard, the US federal funds rate (the benchmark for lending in the US) was immediately reduced to 0.25% in Apr 2020 from 1.75% in Feb 2021. The RBI, not wanting to be left behind, reacted in a similar fashion, slashing the repo rate from 5.15% pre-covid to 4.4% in April and further down to 4.0% in June (and it remains unchanged to date). These decisions were made in times when credit offtake was sluggish, and investments had slowed down in the economy.

                                              

These rates had a massive impact on the markets and the economy. Although intended to encourage consumer spending and business investment, in a time of unprecedented uncertainty, this cheap money started finding its way into the equity markets.

The discounted cash flow method is the most common way to value large cash generating businesses. With the risk-free rate touching rock bottom, theoretically long term intrinsic value of public listed companies suddenly looked very attractive, and people poured money in from all quarters.

2.   The big spend

Unprecedented times called for unprecedented measures. The US Congress announced massive stimulus measures to arrest the economic damage due to COVID-19. The U.S. $2.2Tn COVID-19 relief package (CARES -The Coronavirus Aid, Relief, and Economic Security Act) was passed in record time. This aggressive fiscal response led to the US printing more dollars than ever before. Over the last year, the M2 money supply (a broad measure of supply of money in the US) increased to a whopping $19.4Tn from $15.35Tn in Jan 2020. If this hasn’t blown your mind already, wait for it - this 1 year augmentation is 21% of all of the US dollars ever printed! Coupled with the Fed’s monetary response, the US had concocted a recipe of massive liquidity.

And they weren’t the only one’s doing this. Governments across the world responded to COVID-19 swiftly and with broad brush strokes painting the entire world green. India wasn’t far behind, but our response was more indirect through schemes and government backed loans rather than direct spending measures.

An interesting article by the New York Times published on 1^st Jan, 2021 helps understand this impact on a micro level.

The US CARES package translated into unemployment benefits with stimulus cheques deposited directly into Americans’ accounts as disposable income. Moreover, the brunt of unemployment was disproportionately borne by unskilled and minimum wage workers (waiters, retail staff, etc.) Those fortunate enough to work in white collar jobs continued to work from home and ended up with more money than before. The result, overall wages fell by only $43Bn while stimulus benefits added nearly a trillion dollars in total disposable personal income.

The end result – Americans had an additional $1.56Tn in personal savings. That is how money trickled down from the stimulus packages in the US.

Moving to India’s economy, the RBI’s preliminary estimates of household savings show a significant increase in the 1^st two quarters post the pandemic. Household savings increased to 21 % of GDP Q1 FY21 up from 4% in Q1 FY20. Similar to the rest of the world, propensity to save had risen massively because of ‘forced saving’ by members employed in the formal sector and increase in precautionary savings amongst people working in the informal sector despite slightly reduced or stagnating income levels. This was a direct response to reported actual and potential job losses and multiple lockdowns in India when discretionary expenditures were reduced greatly.

And this story played out across the world with every major economy realising larger savings immediately post the pandemic. As seen in the chart below, quarter ending Jun-20 saw the highest rates of savings as % of GDP.

3.   Rise of the small guys

The third and most critical chain of events of how the stock markets rose can be attributed more towards behavioural psychology rather than macro-economic trends.

As we know, discount brokers have democratised investing in the stock market. Robinhood in the US & Zerodha in India are now the leaders in the industry. Easy access to information and simple trading tools coupled with excess savings during the pandemic opened the flood gates for amateur stock traders. Many working professionals tried their hand at investing and before we knew it, retail traders across the world were pouring their savings into the stock market.

The total number of stock positions in Robinhood in May 2020 almost doubled to 32 million from 16 million in May 2020. India too saw a similar trend tracked here by the number of demat accounts in FY 2021 soaring to 1.1Cr, the highest in the last decade. More prudent individuals ended up investing indirectly through mutual funds and other financial intermediaries. This is how all the excess liquidity found its way in the financial markets.

This liquidity had a spill over effect closer to home for our industry in the form of extremely jubilant primary listing markets. Within a few months, despair turned into home runs for VCs, who started eyeing multi-billion dollar exits through IPOs.

2020 was the best year for IPO issuances world over. $168Bn was raised in the US alone, a twenty year record. In fact, more money was raised in 2020 compared to the last three years put together!

This massive surge can be attributed to the hottest new financial product – SPACs. Investors lapped up SPACs all through the second half of 2020 and the trend has continued in 2021. So far $88Bn has already been raised through SPACs in the US in the first 3 months, far outpacing 2020 at an average of $1bn/day.

As of 26^th Mar 2021, there are 432 SPACs actively searching for targets with over a $139Bn to invest. 

Taking advantage of this excess liquidity in the primary markets, tech companies like AirBnB, DoorDash, Palantir, Snowflake ended up raising billions of dollars. AirBnB will go down as a classic turnaround story in terms of their strategy. At the beginning of the pandemic, they seemed to be the most affected as the leaders in the travel and leisure space. Mass layoffs were the order of the day. But within a few months, the perception completely changed due to 3 key reasons – (i) pure tech & asset light business (all costs could be passed on to homeowners), (ii) growing demand for homestays as people who were travelling wanted to avoid large format hotels and (iii) pent up demand and excess savings from the pandemic expected to be splurged as the economy revives. AirBnB ended up raising a mammoth $3.5Bn and gained a 113% on listing day. Such is the power of liquidity.

In India, 2020 was the 3^rd highest year in terms of IPO activity and the 2^nd in terms of average deal size.

Although there weren’t any major tech companies that listed in India, the stage is set for 2021. Zomato, Delhivery, Nykaa, FlipKart, Policy Bazaar, MobiKwik, Freshworks all have disclosed plans of raising in the primary markets. And there is a whole list of other Indian start-ups looking to list internationally using the SPAC route.

So, to sum it up, it wasn’t just lowered interest rates or excess money supply that has accelerated the stock market over the last one year. It was also the depressed asset prices at the beginning of the pandemic that really fuelled average investors across the world to borrow cheap and invest in the stock market. The stimulus packages created by governments to keep the economy ticking ended up as a liquidity surge that have boosted the equity markets.

Thus, we have found ourselves in a spot where the equity market seems to far outpace the underlying economy. All eyes are now on economic activity to recover and catch up to the markets in terms of earnings. But until that day comes, we can continue to expect the unexpected and hopefully see the companies in our venture ecosystem finally achieve their holy grail of being publicly traded.