Is the stock market out of line?

It is. I say this because I think that as the stock market climbs by nearly 60 per cent in the past six months, its rise is not in sync with our economic fundamentals, or the pace of economic activity, which is slow.

And economic fundamentals determine the stock market’s overall direction. It cannot be otherwise, because buying stocks means buying a share of future profits, which depend on the pace of economic activity.

But then the question is if gross domestic product (which is a measure of economic activity), is crawling up barely 2.0 per cent, why then are investors now cheerfully pouring money into the stock market?

One reason could be that profits of some companies traded on the stock market have indeed surged. But this happened without an economic boom. And it could be explained by monopoly power (including undue concessions taken from the government) and windfall profits, such as Rs275 billion profit last year earned by just five banks, partly by speculating in foreign exchange and earning money from high-yielding government securities.

Another reason is that because economic activity is slow, investment options other than the stock market are absent.

A third reason is that foreign money is pouring into the stock market: $36 million in the last five months. But this is very likely ‘hot money,’ which is pouring in to create an artificial boom, and to abruptly pull out at the peak and profit at the expense of ‘dumb money’.

A good example of hot money is the foreign money poured into the stock markets of the ‘miracle economies’ of Southeast Asia in 1997. Within months it was in full flight, after raking in huge profits by cashing in at the market’s peak. Herein is a lesson for us.

Yet, the puzzle is, so far no one has raised red flags. Instead, serious sounding people assure us there is more to come; that the benchmark index of the Pakistan Stock Exchange will soon reach 75,000. Even top government leaders are caught up in the frenzy.

And serious-sounding people invent all kinds of rationales for the stock market’s ascent: that investor confidence has soared due to the government’s ‘good’ performance (by which they mean signing the IMF loan agreement); gobs of Arab money will soon pour in, and so on.

But such rationales aside, I am afraid that later, if not soon, the stock market will meet up again with the law of gravity, and return to earth. And when it does, that is, when the stock market bubble bursts, aka market ‘correction’, a lot of people are hurt and not just the miserable lot who buy stocks near the peak (aka dumb money).

And make no mistake: the stock market is no snapshot of the national mood, which is grim due to unabating inflation, increasing poverty and widespread discontent. It is no bellwether of any miraculous new economy, as it was made out in the case of the Southeast Asian economies in 1997. Neither is it a report card on the country’s financial health nor on the performance of the government’s economic team, as falsely claimed at the Pakistan Stock Exchange ceremony last Sunday.

Long ago, economist Paul Samuelson debunked such claims with his famous quip that the stock market had predicted nine of the past five recessions. Which neatly summarizes the volatility of stock prices and warns against relying on the stock market as a forecaster of the economy.

And in the 1990s, Alan Greenspan who was heading America’s central bank coined the term ‘irrational exuberance’ to describe the disconnect between the actual worth of companies (traded on the stock exchange) and what investors imagine it to be. It is simply an upbeat feeling, he says, that is based on unjustified optimism about increases in stock prices.

‘Irrational Exuberance’ is also the title of a book by another economist Robert Shiller. He explains the unjustified optimism about surging stock prices as a psychological problem: stock traders, he says, like any people, are overconfident about their plans. They see in economic data that which they wish to see. And they give less importance to the future, that is, to economic fundamentals, and more to the present or short-term.

Schiller addresses American economic actors, but he would surely see through the present irrational exuberance of our economic actors.

The point is, let’s not get caught up in irrational exuberance by a temporarily surging stock market. And let’s remove instability from the stock market by separating the rational from the irrational feeling that drives it. However, if government leaders, who should be alerting us about this, are as well caught up in the stock market frenzy then it is a matter of serious concern.

Because if government decisions are based on the perception that the surging stock market endorses its policies, and foretells miraculous economic growth, and these perceptions are obviously mistaken, then the government’s decisions are mistaken. Which raises doubts about its connection with reality, as well with the fundamental problems of the people that it should be addressing.

No government can carry on proper policy when it ignores glaring facts about the people’s welfare.

And these facts are: 95 million of us are poor and more are becoming poor each day because of uncontrolled inflation. Almost 200 million cannot afford a healthy diet. Twenty-two million women are anemic. Two million infants are too thin, and 10 million are too short because of chronic hunger. This all tells you there is ‘something rotten in the state’ of our economic management.

So, if we are seriously concerned about improving the people’s welfare, let’s not be distracted by the stock market’s irrational exuberance. Instead, let’s single-mindedly address our real issues which are unbridled inflation, poverty, hunger and malnutrition. And invest in people, in their education, health and training.

Because the only way to grow fast permanently (and underpin a robust stock market) is to develop an educated, healthy, skilled and trained labour force.

The writer is a freelance contributor. He can be reached at: Khwaja.Sarmad@gmail.com