Gold prices have recently surged to a new all-time high, breaking free from a prolonged range between $1800 and $2100. In contrast, silver has not yet displayed clear signs of entering a bull market. Since the inception of being freely priced in August 1971, gold has significantly outperformed silver.
As of February 2024, gold has shown a Compound Annual Growth Rate (CAGR) of 8%, reaching a price of 5290. Meanwhile, silver has recorded a CAGR of 5.6%, with a price of 1676.
Number of Firms Reporting Losses At Record Lows
The number of companies reporting losses has reached record lows due to increased profitability driven by cost-cutting measures, improved efficiency, and a surge in demand following the COVID-19 pandemic.
The remarkable decrease in loss-making firms can be attributed to the overall improvement in financial conditions, substantial government spending driven by a high fiscal deficit, and a stable external environment for India. Additionally, India’s resilient economic growth has played a crucial role in this trend.
Such a convergence of factors is rare and has occurred over the past three years. If these conditions persist, the trend of higher corporate profitability is likely to remain robust in the long term.
Tracking this data over time will provide valuable insights into the health and sustainability of corporate profitability.
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PAT Growth Outpacing Nominal GDP Near It’s Best Reading
Profit After Tax (PAT) growth has been surpassing nominal GDP growth, reaching one of its highest levels. This trend has contributed to the extreme readings in equity markets, as indicated by the Market Cap to M2 ratio. Over the past four years, the BSE 500 Index has shown higher PAT growth compared to nominal GDP growth.
Historically, such outperformance of profit growth is characteristic of bull markets. Instances where profit growth exceeds nominal GDP growth have consistently coincided with strong equity market performance. The highest recorded differential, on a rolling 3-year Compound Annual Growth Rate (CAGR) basis, was observed in 2007 at 15%. By the end of FY24, this differential had reached 14.2%.
However, there are signs of a potential normalization in this trend. With nominal GDP growth slowing, sales growth for the BSE 500 Index also decelerating, and margins showing signs of peaking and contracting, there could be pressure on stock prices in FY25. It is becoming progressively challenging for the PAT growth CAGR to maintain its current pace.
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Equity Risk Premium Has Evaporated
The equity risk premium (ERP) has diminished significantly, raising concerns among investors. ERP is the additional return that investors expect from stocks compared to risk-free investments like government bonds. It compensates investors for the higher volatility associated with stocks.
To calculate ERP, you subtract the risk-free rate from the expected return on the stock market. The size of the equity risk premium fluctuates based on the perceived level of risk in the market. Interestingly, perceived risk and actual risk often diverge. When risk perception is low, there’s a tendency towards complacency, increasing the likelihood of below-average investment returns.
The current level of ERP is reminiscent of the period just before the 2008 global financial crisis, when it was similarly low. While this doesn’t predict an impending crisis, it does suggest a similar disregard for risk in the market. Investors should be cautious and consider the implications of a low equity risk premium on their investment strategies.
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