Stock markets are always an enigma as very often it is hard to rationally explain price movements. Market transactions which determine the final price on a real time basis could be driven by several factors and often it is difficult to distinguish between a forward looking view and a contemporary one. A press conference on GST can buoy the markets either way, but it would be back to normal the next day. This is what makes it challenging to take a view on prices.
Add to this the plethora of advice that the reader or viewer gets on individual stocks every day, and one can be confused about investing for a long term horizon, as one can never be sure whether it is the right time to buy or sell. And, much like the economic forecasts where economists have an array of numbers for the same variable, two experts could be advising differently—one to buy and the other to sell the same stock.
Is there any sense in these numbers? For example, if one looks at the banking stocks today, the NSE sectoral index shows that since April there has been an upward movement at a time when the banking problem has been very much deep rooted. The talk is on merging PSBs and infusing capital, and there was gloom when uttering the word ‘banks’. But the announcement that there could be a solution in the offing on NPAs through the IBC has spurred a revival in confidence in these stocks and the sentiment is positive. Otherwise, for a sector which is still looking for the proverbial light at the end of the tunnel, there should be despondency everywhere.
A way out is to see if stock indices reflect the core strength of the economy and the best way out is to look at the GDP. This can be done over a longer period of time logically, and annual numbers make sense. In fact, even monthly data on variables like industrial growth, inflation, interest rates, primary issuances, etc, do not link well with stock movements, though FPIs have a better fit. Very short-run influences would be nebulous as with stagnation in the industry, growing NPAs, limited private investment and a decline in credit growth, stock market sentiment cannot logically be positive or change that soon. Of course, experts aver that stock prices are forward looking and if the expected earnings justify a forward looking number then they should also be ahead of the curve. At times it is argued that as future earnings matter more than the past; hence rising stock market heralds only better times.
At the other end, mutual funds are singing a lilting tune with almost every scheme showing fabulous returns over five years, which gives the impression that any such investment would have beaten the market. This is intuitively not surprising because if the Nifty is reigning at an all-time high, any comparison with earlier years would necessarily denote such high returns and would increase if one moved back in time.
Therefore, ideally, an average index for the year is more appropriate as it isolates these end point swings which can kill the good mood. This average movement in the Nifty can be compared over time to gauge whether or not it has kept pace with GDP growth. This would be a pragmatic way of looking at such relationships.
The table alongside provides information on GDP growth since 2006-07 and average Nifty for each of the years up to 2016-17.
The table shows that up to 2015-16, in general, the stock market movements were in line with the GDP growth rate of higher growth in the latter being associated with higher Nifty movements. 2012-13 was the only exception where the Nifty went up by 5.3%, even as GDP growth slowed down from 6.7% to 5.5% (this would hold even with the earlier the base year of 2004-05). The year 2015-16, witnessed virtual stagnancy in the Nifty on an average basis, but GDP growth increased at a higher rate. Very significantly in 2008-09, following the global financial crisis, the Nifty had almost crashed by around 24% as GDP growth also slowed down by a little over 250 bps.
The major anomaly was 2016-17 when GDP growth slowed down quite distinctly from 8% to 7.1%. Yet, the Nifty has increased by 5.6% and this enthusiasm carries on even today with the market moving by an average of 12% in the three-months period over 2016-17, which is remarkable. Growth indicators have not quite started looking up as yet though there is the ubiquitous hope that it should happen in the second half of the year.
The movement in 2016-17 was surprising because it came at a time when the government went in for demonetisation, which did push back growth to a significant extent. However, if a reason has to be ascribed, the credit for higher FPI funds coming in, which is the main driver, can be attributed to the reforms agenda of the government especially with the expected determined implementation of the GST. Also, the demonetisation move could have been interpreted positively as a frontal attack on black money which is expected to yield long term gains when combined with GST. Therefore, the rise can be attributed more due to positive sentiment than any parallels being witnessed in the growth canvas.
These numbers, hence, do indicate that if stocks have to be correlated with GDP growth over a longer period of time of say a year, on an average they would reflect well the state of the economy. Can the Nifty then be taken to be a leading indicator of the economy? Probably, yes, because in seven of the 10 years, the relation did hold and in another one, 2015-16, one would not have lost. The current situation, however, still warrants raised eyebrows, but as all expectations are that the economy will do only better than 7.1% this year, then rising stock prices must signal the same, though the extent may be interpreted as being a trifle exaggerated. But for long term investors, getting in may not be a bad idea still if one is looking at a longer term horizon when GDP growth should be ascending the scale and move towards the 8-9% mark. To put it conversely, if we expect higher growth in future, then the returns on the bourses must also get better.
Short-term investors, however, can never be sure, but probably that is the thrill about such investing.