The make-or-break speculative investment
DONALD Trump, who believes all his political rivals are ‘communists’, is suddenly sounding like one. He recently said that the record highs in the US stock markets “are making rich people richer.” Guess what, Mr Trump? That has always been true about stock markets everywhere in the world. The markets track corporate profits. If profits go up, the markets rise. They rise faster when corporates get a higher share of the total national income. That is exactly what has been happening since the 1980s, and that is also the secret behind the phenomenal returns from stock markets since then.
Forty years ago, the US prided itself on being the land of small entrepreneurs. Since then, capital has got concentrated in the hands of a few big companies. Now, when profits increase, it means the rich get richer. They invest their savings in the markets, which in turn rise and further increase their wealth.
It is true that a large number of American citizens own shares directly or indirectly through mutual funds or retirement accounts. In 2022, for instance, 58 per cent of the households in the US had made some amount of direct or indirect share market investments. But breaking down this number by income levels shows that only 34 per cent of the bottom half of families owned shares. Compare that to the richest 10 per cent, where 95 per cent of the families had invested in the stock markets. The median stock market holding of the bottom half was just $12,600, while the median value of stock investments for the richest 10 per cent was $608,000. So, Trump is right that a rising stock market means more money goes to the affluent.
What does it mean for us? In India, the richest 1 per cent own about one-third of all the wealth. That means about 35 lakh families own assets worth about $5 trillion. That is approximately Rs 415 lakh crore. Last year, India’s net personal wealth increased by 4.6 per cent. Given the concentration of wealth in our country, it is not unreasonable to say that the wealth held by the top 1 per cent would have increased by at least 5 per cent. If we assume that is going to get repeated this year, India’s richest families will have added another Rs 20 lakh crore to their personal wealth.
A large chunk of that money is just a change in the value of their assets and cannot be readily monetised. If we assume that one-fourth of the additional wealth will be reinvested, we can expect another Rs 5 lakh crore to flow into conspicuous consumption and buying new assets. Let’s say that half of this goes into the stock markets. That means about $30 billion of the money held by the rich can potentially come as fresh investments into the Indian markets next year.
This is not an impossible number, considering domestic funds have invested more than $20 billion in Indian stocks and shares in 2023. Along with the $15 billion pumped by foreign funds, the investments made by India’s rich have helped Nifty give a return of nearly 20 per cent this year. If all things remain the same — and they don’t ever — one shouldn’t be surprised if the markets give handsome returns in 2024 as well.
There is one more reason to believe that 2024 could be good for the rich. The US Federal Reserve — America’s central bank — has already indicated that there will be several interest rate cuts in the new year. That means it will become easier for American investors to borrow and invest in the stock markets and other assets. Some of that money will flow into the Indian share markets as well.
On top of that, if the Fed cuts rates, the RBI will be tempted to follow suit. There will be more easy money in our domestic economy, which again will increase flows into stocks and shares. If interest rates fall, corporate finance costs will also drop, increasing their profit margins. Since markets track corporate profits, this is yet another reason for share prices to rise.
There is one rider to this rosy picture — the massive amounts of speculative investments that ordinary ‘retail’ investors appear to have made in the Indian markets. This can be gauged from the amount of money that has gone into the riskier futures and derivatives markets. Here, investors put up small amounts of money to bet on which way prices will move in the future. For instance, you could bet that a share that is worth Rs 100 today will go up to Rs 115 by the end of the month. You could buy the option to buy the shares at a future date for Rs 110. If it does go to Rs 115, you will make a profit of Rs 5 per share, but if it only rises to Rs 105, you will end up losing Rs 5 per share. Obviously, big money can be made only if you buy large volumes of shares. In order to make Rs 1 lakh, you will need to buy 20,000 shares.
In the cash market, you would have had to spend Rs 20 lakh to buy 20,000 shares at Rs 100 each. In the derivatives market, you only put a margin amount, let’s say only 10 per cent or Rs 2 lakh. If the share price goes to Rs 115, you will make Rs 5 lakh profit by putting up only Rs 2 lakh — that’s a 150 per cent return. But if the share goes to Rs 105, you will lose Rs 5 lakh over and above the Rs 2 lakh you originally invested.
This kind of speculative investment has run riot in India. In other markets, the derivatives-to-cash market ratio is about 5-10 times. In India, it is 400 times. This suggests that any sharp drop in the markets will bring about a massive payments’ crisis and a ton of bad loans.
As usual, the rich will survive, thanks to their deep pockets. It is the retail investor who could get wiped out.
The author is a senior economic analyst
