by Dr. V K Vijayakumar
Economy is a dynamic entity. Economic activity is cyclical, not linear. Therefore, when the economy moves up or down in the cycle, it leads to substantial changes in macro economic indicators. The market anticipates these changes and moves ahead much faster. That’s why a market crash precedes a recession; and sustained bull rally is initiated before a boom. Sometimes, the cycle sustains for years. Indian economy and the stock market are at interesting points in the cycle.
In this age of globalization the global economic environment is crucial. Also, globally markets are integrated. A major market crash in the Developed World, particularly in the USA, would impact markets across the world, as we saw in February this year when the Dow crashed by more than 1000 points twice. So the tailwinds and the headwinds for the global economy and global markets in 2018 are important for our economy and markets too.
The global economy is in fine shape. It is going through the best expansion since the Great Recession of 2008-09. The unique feature of this global growth is that this is a synchronized global growth. International trade is growing steadily. There are no major trouble spots in the global economy. This global growth recovery can continue for a few more years before another cyclical downturn gets triggered.
Indian economy is firmly on the path of cyclical recovery
The Indian economy is on the path of cyclical recovery. The twin shocks of demonetization and GST implementation are behind us. Macroeconomic indicators are signaling a sharp economic recovery. Now it is safe to conclude that the Indian economy bottomed out in Q1 FY 2018 when the GDP growth rate plummeted to 5.7 percent. Thereafter, the growth rate climbed to 6.5 percent and 7.2 percent respectively for Q2 and Q3. The growth rate for Q4 will be higher than 7 percent enabling FY 2018 growth rate to touch 6.7 percent. There is a global consensus presently that India would reemerge as the fastest growing large economy in the world in 2018.
Investment picking up after a long gap
The Q3 GDP disaggregated data has some important signals. Manufacturing growth has picked up to 8.1 percent and construction has picked up to 6.8 percent after stagnating at 3 percent for long. The big positive is the turnaround in investment, which has been the under performer for long. Gross Fixed Capital Formation (GSFC), which maps investment in the economy, has grown by 12 percent in Q3. This is a clear trend reversal that can initiate a virtuous cycle in the economy. Increase in investment will push up the growth rate, which, in turn, will improve the demand in the economy. This will push up the capacity utilization in industry, necessitating further investment leading to higher growth.This virtuous cycle will gather momentum, going forward. Important data such as traffic, freight and automobile sales support this virtuous cycle hypothesis.
Of course, there are some concerns. Will the PNB scam thwart credit growth and cyclical recovery? In the context of the scam, the PSU bank recap now appears inadequate to fund credit growth that is badly needed to sustain the investment recovery. There are also serious concerns whether the regulatory overkill following the scam might impact investment and growth.
Healthy macros and improving micros
During the last 3 years, even with good macros, micros (performance of companies) were tepid. This is changing now. With the turnaround in GDP growth rate, India’s macros are improving. Fiscal deficit and CAD are under control. Inflation in February surprised on the downside with CPI inflation at 4.44 percent and WPI inflation declined to 2.84 percent. This preempts the fear of a rate hike this year and therefore is favorable for the markets.
Healthy macros are improving the micros. Q3 earnings were better than the street expectations and Q4 would be much better. The macro environment favors a sustained pick up in corporate earnings in FY 2019 and beyond. This is the turn of the cycle. High teens earnings growth potential will make market valuations reasonable. This is the medium to long-term story. In the short-term, however, there are many headwinds, which can impact the economy and markets.
Concerns of a global trade war
A trade war is destructive for everyone (trade war was a major contributing factor to the Great Depression of 1930s) and therefore the general consensus is that it is unlikely. The recent decision of the Trump administration to impose import duty of 25 percent on steel and 10 percent on aluminum is widely regarded as posturing for better negotiation. However, this should not be dismissed lightly. Earlier Trump scrapped the Tran-Pacific Partnership and forced renegotiation of NAFTA. Therefore, we cannot rule out more triggers by Trump targeting other countries, particularly China; and if others retaliate by increasing tariffs on imports from US, an ugly trade war may erupt damaging global economic recovery and trade. This can have bad consequences for markets. As the IMF chief Christine Lagarde remarked, “trade war is not only destructive for everyone, but unwinnable also.” Let’s hope sanity will prevail.
The Indian political landscape has been changing rapidly and looks all set to spring surprises, which can have major impact on markets. The market has not discounted a non-NDA government in 2019. The market sets high score for the PM. Till recently a non-NDA government in 2019 did not appear even as a remote possibility. Even now it is advantage NDA in the General Elections scheduled for 2019, but it is no longer a certainty as it was a few months back. The recent UP election results indicate that a combined opposition would be a force to reckon with. This has serious implications for markets. Investors need to watch out for the political developments.
The market is presently caught in the cross fire of these headwinds and tailwinds. Investors should remain calm and use corrections as opportunities to buy quality stocks, preferably large caps and high quality midcaps. Continue with the SIPs. Patience will be rewarded.