A ripple of concern is passing through the country on the Central Statistical Organisation reducing the GDP growth estimate for 2012-13 down to 5 per cent. This is the lowest reading since the first quarter of 2009.
But do investors really need to worry about this slowdown? Not really, because the link between the GDP growth number and stock price moves is tenuous. But drilling down to the growth rate in various components of GDP can provide some useful insights to investors on how to deal with specific sectors.
An analysis of the correlation (a statistical measure of how two sets of data move in relation to each other) between nominal GDP growth and CNX 500 shows a weak link between the two.
Between 2008 and 2012, the correlation was negative in three years, implying that the two data sets moved in opposite directions.
That stock prices take scant note of overall economic growth is brought out well in the numbers recorded in 2012. Even as growth in nominal GDP growth slowed from 14.7 per cent to 13.6 per cent in the first three quarters of 2012, the CNX 500 index gained 25 per cent.
Stock prices have displayed similar nonchalance towards economic growth in the past too. In the period between September 1998 and March 2001, nominal GDP growth slowed from 17.9 to 5.4 per cent. CNX 500 was up 21 per cent in that period. Between March 2010 and December 2012 too CNX 500 registered gains even as the economic growth slumped.
The exception to this trend is in periods of protracted expansion in economy as was evidenced between December 2002 and September 2008. Gains in CNX 500 index kept pace with the accelerating economic growth in this period.
Explaining the disconnect
There are many reasons why stock prices are immune to economic slowdown. For one, stock prices are determined mainly by the twin forces of demand and supply. The demand for stocks, especially from overseas investors or foreign institutional investors (FIIs), has been the overriding factor in determining stock price movement in our country.
For instance, between March and November 2010, stock prices continued surging even as GDP growth rate turned adverse. FIIs ploughed in $24 billion in secondary market in this period. The same was true in 2012 too with a surge of FII money lifting stock prices despite negative economic numbers.
And why do FIIs invest in a country with a slowing economic growth? FIIs have the choice to invest across the globe. Even with a GDP growth that is slowing, India could continue to be an attractive investment destination when compared with the growth rates of most other developed or emerging economies.
Another reason for this disconnect is that stock prices move on expectation of future growth. They tend to anticipate and factor in changes in economic growth long before the deceleration or acceleration actually begins. This results in stocks registering large up and down moves before the GDP numbers reflect the change.
Again, stocks react to news much before the impact of the news starts reflecting in GDP numbers. Take, for instance, the 2008 meltdown. Stock prices reversed in January 2008 as soon as the contours of the sub-prime crisis and its fallout emerged. By the time the event caused a slowdown in GDP growth rate in September 2008, CNX 500 had already lost 35 per cent of its value.
GDP and revenue
The link between GDP growth rate and corporate revenue growth for a given period is again difficult to establish. Correlation between growth in net sales of listed companies and GDP growth threw up a negative correlation in the years between FY 04 and FY 12. But when we repeated the exercise with the revenue growth of a year correlated with the GDP growth of the previous year, the link was stronger, at 0.58.
This could be because it usually takes time for a slowdown to percolate to factors such as consumer confidence and erosion of pricing power, which lead to slower revenue growth. This results in the lag between the change in GDP growth rate getting reflected in corporate revenue. So keeping an eye on the GDP can give us an indication of what to expect from companies’ top-line in subsequent periods.
Tracking GDP components
While tracking the overall GDP numbers might not be of much use to investors, tracking the growth in the various components of the GDP does help in investment decisions.
When GDP slows or accelerates, not all of its components — such as agriculture, forestry and fishing, mining and quarrying, manufacturing — move in tandem. It could be just one of these segments that could be dragging or boosting economic growth. And prices of stocks in the affected segment tend to reflect this change.
For instance, in the period between September 1998 and March 2001, drop in nominal GDP growth rate was led by slowdown in agriculture whose growth decelerated from 13.9 to -4.5 per. Stock prices of Rallis India, GSFC, Tata Chemicals, BASF were down between 60 and 70 per cent in this period. Similarly, in the period between March 2010 and September 2012 (ongoing GDP slowdown), growth rates in manufacturing, mining and quarrying, agriculture and trade, hotel, transport and communication have more than halved. Not surprisingly, the loser’s list in this period sports names such as BHEL, Bajaj Hindustan, Bharat Electronics, Crompton Greaves, Indian Hotels, Sesa Goa, Nalco, Balrampur Chini and so on.
Can slowing consumption and high inflation co-exist?
The question puzzling analysts in the recent past is, why is inflation showing no sign of abating even as consumption is slowing down.
Private Final Consumption Expenditure (PFCE), which represents the money spent by households on purchase of durable and non-durable goods and services (excluding land), has slowed down from a yearly growth of 8.1 per cent in 2010-11 to 4.1 per cent in 2012-13. Gross fixed capital formation (GFCF), which represents the fixed assets added, is also down from growth of 7.5 per cent to 2.5 per cent in the same period. Consumer price inflation, however, continues to grow above 10 per cent.
According to the Centre for Monitoring Indian Economy, the explanation for why inflation continues to be high despite these slowing numbers lies in the data used to compute the PFCE and GFCF numbers.
The CSO arrives at the PFCE figures from the output of the producers. The slowdown in output of consumer goods and agricultural produce in recent quarters is reflected as a slowing PFCE. Thus, what high inflation implies is that supply is slowing even though demand is robust, hence driving up prices.
Similarly, the CSO uses the output of capital goods and construction materials to arrive at the numbers for GFCF. It goes without saying that the slowdown in these segments is reflected in slowing GFCF.