Making sense of equity markets is a challenge: Look at RBI’s attempt
The Reserve Bank of India’s (RBI) working paper, Equity Markets and Monetary Policy Surprises, March 2024, is yet another attempt to make sense of the unfathomable ways of equity markets. This time, from the perspective of monetary policy; in particular, market expectations of the future path of policy and the impact of central bank communication and surprises on markets. Over the years, economists, financial wizards and others have tried to explain why stock markets behave the way they do.
With limited success, or worse. We have a range 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 one of these theories—some of which even won their theorists Nobel prizes—has stood the test of time.
Markets, almost invariably, seem to have the last laugh. What can possibly explain the dizzying speed at which markets—whether in India or the US—have run up in the post-covid years, a period marked by a global slowdown in economic growth? Remember, India’s quarterly GDP contracted by nearly 24% in the first quarter of 2020-21, while the US was expected to tip into recession. Sure, both economies have recorded sterling recoveries since, with the US appearing to defy attempts of the US Federal Reserve to slow it down.
And India is expected to be one of the world’s fastest growing major economies, even as China struggles to regain its eminence as an engine of growth. But that alone does not quite explain why the S&P BSE Sensex was up 68% in covid year 2020-21 (it is up 25% in the period from 1 March 2022 to 26 April 2024). One can point to surplus liquidity, thanks to quantitative easing by
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