Making sense of equity markets is a challenge: Look at RBI’s attempt

We person a scope of theories, from the Efficient Market Hypothesis and Random Walk Theory to Modern Portfolio Theory, Capital Asset Pricing Model and the Arbitrage Pricing Theory, among others. Unfortunately, not 1 of these theories—some of which adjacent won their theorists Nobel prizes—has stood the trial of time. Markets, astir invariably, look to person the past laugh. What tin perchance explicate the dizzying velocity astatine which markets—whether successful India oregon the US—have tally up successful the post-covid years, a play marked by a planetary slowdown successful economical growth? Remember, India’s quarterly GDP contracted by astir 24% successful the archetypal 4th of 2020-21, portion the US was expected to extremity into recession.

Sure, some economies person recorded sterling recoveries since, with the US appearing to defy attempts of the US Federal Reserve to dilatory it down. And India is expected to beryllium 1 of the world’s fastest increasing large economies, adjacent arsenic China struggles to regain its eminence arsenic an motor of growth. But that unsocial does not rather explicate wherefore the S&P BSE Sensex was up 68% successful covid twelvemonth 2020-21 (it is up 25% successful the play from 1 March 2022 to 26 April 2024). One tin constituent to surplus liquidity, acknowledgment to quantitative easing by cardinal banks trying to tackle the pandemic’s fallout. Never caput that they person shifted to quantitative tightening, starting immoderate 2 years ago. But tin liquidity unsocial explicate markets? Sadly, no. Which is wherefore RBI’s caller moving insubstantial is simply a invited summation to the lit connected this subject. 

It is existent that “financial markets thin to respond instantaneously with the merchandise of caller accusation and marketplace prices bespeak expectations astir aboriginal economical and monetary developments." It is besides existent that marketplace participants “typically extract accusation from the cardinal bank’s monetary argumentation communication." Further, their reactions are coloured by whether argumentation actions were anticipated and incorporated into their decisions oregon not, with unanticipated changes much apt to interaction markets. 

Using information connected overnight indexed swaps, an interest-rate swap whose floating limb is linked to an overnight index, compounded each time implicit the outgo period, the survey concludes that “equity returns connected argumentation announcement days are impacted lone by the market’s expectations of the aboriginal monetary argumentation trajectory." Also, volatility successful equity prices is affected by the astonishment constituent of monetary argumentation and cardinal slope messaging. Overall, equity markets are affected much by changes successful marketplace expectations of aboriginal monetary argumentation than by argumentation complaint surprises.

Whether each this leaves america immoderate wiser successful our grasp of equity markets remains to beryllium seen. For now, the enactment seems endless. Sure, we’ve seen corrections from clip to time. But arsenic Citigroup’s erstwhile CEO Chuck Prince erstwhile enactment it, “As agelong arsenic the euphony is playing, you’ve got to get up and dance." Dance, galore surely will. But don’t stake connected an endless party.