Caution on RBI's caution

The RBI has issued a word of caution against the ongoing bull run in equity market and termed it a "Bubble". This hasty and baseless statement of RBI has the power to send a shiver down the spine of investors. 

Without getting into under what capacity let's just focus on the groundless "Caution".

RBI, while stating "This order of asset price inflation in the context of the estimated 8% contraction of GDP in 2020-21 poses the risk of a bubble", assumed that an economic contraction would significantly affect the corporate balance sheets of the few listed companies out of the millions present in India without giving a thought to the fact that most of these companies because of limited reserves, might be forced to scale down or, in the worst case scenario, shut operations. This phenomenon of elimination of weak hands, if I put it crudely, would result in passing of their businesses to the huge corporates, who have enough reserves to see them through the pandemic, most of them having a presence on the exchange.

To support this aforementioned argument let's look at the P/E ratio, a ratio which simply shows how overvalued the price of a particular stock is vis-a-vis its earning, of Nifty. 

The P/E of Nifty index before pandemic was in the range of 24-25, meaning for every one rupee earned investors were willing to pay 24-25 rs for the Index. The P/E ratio started escalating from 30 in August 2020 and went as high as 40 in March 2021. Here comes the best part, the P/E fell to 32.73 in April 2021 and 29.27 in May 2021(same as in June 2019, before pandemic) despite the market continuing its bull run, this put simply means that the corporate balance sheets did really well. The prices of shares of companies were more costlier, in May 2021, than they were in June 2019 but at the same time their earnings are in tandem compared to their earnings in June of 2019, as this is evident by the same P/E ratio.

Many companies posted their best ever quarterly results, supply side constraints favoured these companies. 

RBI's job is not to disrupt the market forces of demand and supply, which it might end up doing by issuing such uninformed statements, these forces should be left uninterrupted to dictate the course of the market.