Today I ask a very simple question. Does the stock market reflect the state of a country’s economy?
Let’s look at some stats. The Indian GDP growth has been about 8% in 2011 and over the last 12 months. But what returns have we seen in the market? The NIFTY performance has been -7.9% YTD and +6.9% over the past 12 months.
Let’s look at the corresponding numbers for the US. The US GDP growth rate has hovered at around 2% this year and is expected to grow at about 2.5% over the rest of the year. What returns have the US markets provided? The Dow Jones performance has been +9.33% YTD and +24.84% over the past 12 months.
How about China? China’s GDP has been growing at around 9.5% consistently for the past 12 months. But its stock market YTD return is around -1% and 1 year return is around +15%.
It is obvious seeing the numbers above that the US market has been the best performing market over the past 12 months inspite of the economy growing at a fraction of the rate of the Chinese and Indian economies. Why is this so? Well, that’s the beauty about stock markets. There is more than what meets the eye.
If we extrapolate the numbers to the last 5 years, the returns in the corresponding markets are 80% in 5 years for Indian SENSEX, 70% for Shanghai and 12% for the US. Does that change things now? J Of course they do. It goes to show that over a long time frame, Indian markets definitely have outperformed but something has gone wrong in the last 12 months for the Indian markets.
If I were to put it differently, a stock market is a ‘perceived’ numerical reflection of a country’s future state of being in comparison with its current state of being . The state of being includes the economic factors as well as socio-political factors. Though the Indian economy has been growing at 8% in the last 12 months, what’s more important is what lies in store for the future.
It is important to understand that the market discounts what lies in the past very quickly. For instance, on the day of Infosys results, the market has a certain expectation. If Infosys performs better than that, the stock price rises dramatically and discounts the aberration. The same happens if the results are below expectations and the price falls drastically. Once this adjustment happens, the stock price once again merely fluctuates in expectation of the future state of being of Infosys. What is also important to understand is that the market expectation for different stocks is relative and based on past performance. For instance, if Infosys grows at say 20% in a certain quarter, its stock price may fall because its past average growth rate has been 25%. Similarly its competitor HCL may grow just 10% in that quarter but its stock price may still go up if its past growth rate has been 5%.
Now coming back to the Indian stock markets, a lot has happened in the past 1 year apart from economy growing at 8%. There are several other indicators that directly or indirectly affect ‘future’ GDP growth. Some important factors as I see them are:
- Inflation
- Employment
- Spike of negative social indicators – eg corruption has been all over the news in the last 12 months
- Global cues
- Major Calamities
- Possibility of war
- Political instability
- Oil price
- Commodity prices
All the above aspects shape the confidence levels of stock market ‘investors that matter’. What I mean to say is that you or I cannot affect the direction of stock markets but there are other investors that matter. One bunch of such investors are FII’s. Similarly domestic institutions and Asset management companies can pump in or withdraw capital from the markets affecting the direction somewhat. They are the investors that matter. In the last 12 months, FII’s and investors that matter have been a little skeptical and cautious about Indian markets. They are keenly following state elections. They are closely watching the corruption scandals dogging the landscape and so on.
Somewhere deep inside there is an apprehension about the immediate future which is preventing that feel-good factor to permeate the mindset. There is no doubt about the long-term India story but India has already set a benchmark of achieving 8-9% growth. Future stock market movement will depend upon how the country performs in relation to the past. For markets to rise, most of the indicators that I have listed above should also be positive, thereby positively impacting ‘future’ GDP.
Hence, just to re-iterate - Stock markets reflect the future state of being of a country. There is a definite co-relation with financial performance of the country’s organizations but investors keep sniffing for other indicators listed because these factors can affect the ‘future’ performance of these organizations. Hence, they act based on what they perceive about the future and that gets reflected in the overall performance of the country’s stock market.
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