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How to deal with an economic slowdown

Jai, Veeru and Gabbar discuss the economic slowdown and what it means for the stock market


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Gabbar seemed to be in great spirits, tucking into two platefuls of jalebis and rabdi at the Lovely Dhaba when Jai and Veeru dropped in.

Gabbar: Hey, come, come. I am celebrating the election result. You can join me, too. See, you were both so cautious about the market last month. Had I known the Sensex would go to 40K, I would have invested a big lump sum in the market. You guys made me do SIPs instead.

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Veeru: You have a very short memory, Gabbar. I remember very well that you wanted to stop your SIPs in March because you were worried about the Pakistan air strikes. We convinced you to continue.

Gabbar: Ha ha! I was just pulling your leg, Veeru. I actually wanted your expert views on the market. Now that the election is over, we can expect FIIs and Indian investors to invest more, can't we? I just got a big sum from my jeejaji and wanted to put that immediately in a mid-cap fund. I can expect bumper returns. What do you say?

Veeru: That the political uncertainty has ended is a good thing, Gabbar. But remember, the market always discounts events before they happen. If you look at market behaviour over the last few elections, there's a big reaction on the results day. But after one or two weeks, everyone forgets the election and is back to looking at usual things like the economy and company performance.

Jai: But the news on the economic front is not good, Veeru. Did you see the fourth quarter GDP numbers in the pink papers? The economy grew only by 5.8 per cent in the January-March quarter of 2019 and by 6.8 per cent for the full year.

Gabbar: Yes, Jai. I was just reading about the auto sales numbers. Horrible. Passenger-car sales across India went up by just 3 per cent in FY19 and fell by 17 per cent in April.

Veeru: I've been seeing those auto numbers quoted everywhere. But I think this gloom and doom over them is overdone. Vehicle sales always slow down just before elections; it happened in 2010 and 2014, too. This year, they were also affected by NBFCs going slow on their loans due to the liquidity crisis and fuel prices being high. Automakers have also been preparing for the new BS-VI norms.

Gabbar: Maybe auto sales were affected by some one-off factors, Veeru. But I'm worried how badly people must be suffering to cut back on even bathing and brushing their teeth! You saw Hindustan Unilever's results? The company said that its volume growth fell to 7 per cent in the March quarter from 10-12 percent in the last four quarters.

Veeru: Don't jump to a conclusion. Have you stopped brushing your teeth? You are getting confused between a fall in growth rate and a contraction in sales, Gabbar. HUL has not sold fewer bars of soap or toothpastes this quarter. Its sales have grown more slowly.

I think that for a company of HUL's size, a 7 per cent volume growth is not at all bad. In fact, it was the 10-12 per cent growth that was unusually high. My theory is that GST made consumers shift from unbranded products to big brands like HUL. It is now more than a year since GST kicked in, so the effect is wearing off.

Jai: I agree with your points on HUL and auto sales, Veeru. But you cannot deny there is a slowdown. Broader indices like the IIP and the GDP numbers tell us the same thing.

Veeru: I do agree there is a slowdown, Jai. I am only saying that we don't know how much of it is due to temporary factors and how much is due to lasting factors. I feel people are taking a very pessimistic view right now based on a few indicators. I can show you some indicators that paint a very positive picture also. If the economy is doing so badly, how did commercial vehicle sales grow by 17 per cent in FY19? If construction is in the dumps, how come cement production be up 13.3 per cent in FY19, double the growth in FY18? Look at what multiplex and hotel companies have said in their March quarter results. They are much more bullish than FMCG or auto companies.

Jai: Hmm, you definitely have a point there, Veeru. In stock investing, one mustn't get carried away by macros. There are always pockets of growth even in a slowing economy.

Veeru: I also think that consumption patterns in India are shifting. Maybe we should not be looking at car sales, etc., to gauge sentiment in the economy. I was just now reading about how millennials hate to own assets like cars and houses but love to borrow and splurge on experiences like holidays and eating out. Young people simply prefer Uber or Ola rides to buying and maintaining a car. My friend, a car dealer, was telling me that he doesn't get any car buyers in the 20-25 age group any more. Only people older than 30!

Gabbar: Yes, I see this shift in my own house. My children can live without lassi, but they need Wi-Fi. I spend half my salary on the Airtel bill and the other half on Swiggy. My Bunty threatened that he won't eat anything until I got him black-market tickets for Avengers!

Jai: The election result also tells us that the ground situation on rural growth, agricultural distress or unemployment may not be as bad as the media makes it out to be. If things were so bad, why would people give such a big majority to the same party?

Veeru: Of course, the other thing we should remember is that there is not much connection between the economy and stock-market returns.

Gabbar: What are you saying? You have only told me so many times that growth is the most important thing and I should not be looking at stock-price movements so much.

Veeru: I think he meant that you should look at corporate profit growth, not GDP growth.

Jai: Exactly. UTI Mutual Fund recently did a research study which showed that stock-market returns are not very strongly connected to GDP growth. It cited some interesting data. Between 2008 and 2017, the Chinese economy grew 8.2 per cent annually, but China's stock index was down by 24 per cent. They also did a correlation between India's real GDP growth and Sensex returns between 1991 and 2018 and found that they had a very low correlation of 0.2.

Gabbar: These statistics are like Tamil and Malayalam to me. Please explain it in simpler terms.

Jai: That low correlation means that GDP and stock-market returns mostly don't move in the same direction, Gabbar. You can have years of high GDP growth but poor stock-market returns; also poor GDP growth and high stock-market returns.

Veeru: That's very interesting! Why is that?

Jai: It may be because stock markets live on hope, Veeru. They often discount good news in anticipation. The last three years have been a classic example. India's GDP growth has slowed from 8.2 per cent in FY17 to 6.8 per cent by FY19. But the Nifty 50 was up 19 per cent in FY17, 10 per cent in FY18 and 15 per cent in FY19. Similarly, the economy was in bad shape in FY14 when NDA-1 took over. But the stock market zoomed, thinking things will get better.

Gabbar: Okay, I get that the GDP numbers don't matter too much for my equity funds. But how about company profits? Do they matter?

Jai: Very right, Gabbar. Stock prices may jump in anticipation of good profits, but if that profit growth doesn't materialise, they can crash, too. On this aspect, there is a bit of worry about Indian markets. Between May 2014 and May 2019, the Nifty 50 has jumped 67 per cent, but do you know how much the profits of Nifty 50 companies have grown in the last five years?

Gabbar: 67 per cent?

Jai: Ha ha, good joke! The Nifty 50 EPS has gone up from `406 in FY14 to `486 in FY19, just 20 per cent over five years.

Veeru: That explains why the Nifty 50's price-earnings (P/E) ratio is now at an expensive 29 times. The 'P' has been shooting up while the 'E' has been moving like Gabbar after a good lunch!

Gabbar: Very funny! So, you are saying that the stock market has gone up expecting very good profit growth but that hasn't happened. So if profit growth doesn't happen soon, then markets can fall.

Jai: That's right, Gabbar. But don't start panicking. Markets are always impatient like you. Corporate banks, which make up a big weight in the Nifty, are now turning around. So analysts are seeing Nifty companies' profit growth picking up sharply this year.

Veeru: Yes, I was just reading a brokerage report that said that in the January-March 2019 quarter, the Nifty 50 profits jumped by 16 per cent compared to the last year. It actually matched market expectations.

Jai: Yes, that's after missing expectations for the last many years! If it sustains, that could automatically bring down the market's P/E.

Veeru: I would prefer to wait and watch. The market P/E tells me that one shouldn't get carried away by election results, Gabbar. Nor am I depressed because of the GDP. If I were you, I would put that lump sum money in a liquid fund and do a systematic transfer into a multi-cap fund.

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