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Investment Strategy in Economic
Slowdown
M S Narasimhan
[email protected]
Economic Outlook and Investment
Strategy
• Investment strategies are broadly three kinds
– BUY-HOLD-SELL Passive Strategy
– Momentum Strategy
– Contrarian Strategy or value investing
• Economic growth is cyclical
• Is there any correlation between stock market
performance and economic growth?
• Whether we should follow different investment
strategies based on economic outlook?
Why Economy takes cyclical growth?
• Capacity building changes supply and demand
conditions excess to shortage
– Ex. Cement and petro-chemical
• Innovations take place at intervals and economy gets
into accelerated growth following an innovation
– Eg. Internet and wireless telecom
• Government intervention in accelerating growth in one
period causes some imbalance in growth and it gets
corrected by slowdown
• Growth is also affected by movement of international
capital flow
Real GDP Growth Rate (India)
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
-2.00%
-4.00%
-6.00%
Real GDP Growth Rate (US)
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
-2.00%
-4.00%
-6.00%
Stock Market Performance and
Economic Growth
• Whether stock market reflects economic
growth?
– YES but not significantly
– Correlation between Sensex and GDP Growth
(1980-2012) : 17.79% ; with one year lag: 8.12%
– Correlation between Dow and US GDP Growth
(1980-2011) : 32.75%; with one year lag: -17.42%
– Economic growth rate is partly influenced by
agricultural growth which is not very high
GDP and Sensex
900.00%
800.00%
700.00%
600.00%
500.00%
400.00%
300.00%
200.00%
100.00%
0.00%
Cum Real GDP
Cum Nominal GDP
Cum Sensex
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
400.00%
1962
1960
1958
1956
1954
1952
Year
GDP and Dow
600.00%
Cum Nominal GDP
500.00%
Cum Real GDP
Cum Dow
300.00%
200.00%
100.00%
0.00%
Importance of GDP Level
Year
Real GDP Growth
Sensex Growth
2001-02
2002-03
2003-04
5.52%
3.99%
8.06%
-3.75%
-12.12%
83.38%
2004-05
6.97%
16.14%
2005-06
9.48%
73.73%
2006-07
2007-08
9.57%
9.32%
15.89%
19.68%
2008-09
2009-10
6.72%
8.39%
-37.94%
80.54%
2010-11
8.39%
10.94%
2011-12
6.48%
-10.50%
Economic Analysis and Investment
Strategy
• Capital allocation between debt and equity is
primarily driven by economic analysis
– Previous table shows it doesn’t make sense to
invest in stock market during economic slowdown
– Investment debt products or fixed deposit makes
sense
– Challenge: Slow down confirmation comes after
six months and by then market is down
– Early warnings come around first quarter end
– Slow down sustains
Momentum Strategy
• Momentum strategy makes sense during
economic boom time
• Momentum indicator gives buy signal only
during economic growth
• A simple moving average based momentum
strategy captures nearly 70% of the high-low
difference
Contrarian Strategy
• A strategy that requires one to buy when
others are selling and sell when others are
buying is contrarian strategy
• Example: Investing in low P/E and P/B Stocks
•
Investing in industry leader stocks
• Challenge: Strategy yields maximum profit if
investments is made towards end of the
slowdown
• Risk: Timing and waiting period
Defensive Strategy
• Some investors prefer defensive stocks during
economic slowdown
• Stocks in pharmaceutical, food processing/
FMCG, power, stocks with low beta, etc., are
generally considered as defensive stock
• Many times, defensive stock may not decline
much but it may not offer positive return
during economic slowdown.
Investment in Commodities and other
Assets
• Commodities offer positive inflation adjusted
return slightly lower than stocks but more than
bonds
• Commodities are negatively correlated with stock
market; performs better than stocks during
economic slowdown
• Gold, silver and real-estates are low-risk class
assets and hence long-term return is low
– Performs better than stocks in economic slowdown
Economic Outlook
• It is difficult to get consensus on future
economic outlook
• Going by recent history, stock market will offer
a great return if economic growth rate turns to
above 9%
– Below 7% will be disaster
– Between 7% & 9%, positive but unattractive return
– In 2012-13, we will be between 7% & 9% mainly
because of agricultural growth and foreign inflow
Economic Outlook
• Whether India will return to 9%+ growth in
2013-14?
– Chances are 50%-50%
– Hopefully, monsoon will be good after two belowaverage years
– Improvement in global economic outlook
– Risk: Political uncertainty
– We don’t have any concrete information at this
point; one can at best make a guess
GDP Growth Estimate
Country
United States
China
Japan
Germany
France
Brazil
UK
Italy
Russia
India
World GDP Estimate (2013-2017) (in billion dollars)
2013
2014
2015
2016
2017
16,221,378 16,940,567 17,783,568 18,705,028 19,704,590
8,777,203
9,641,851 10,581,052 11,598,974 12,713,864
6,060,834
6,207,665
6,372,229
6,531,077
6,695,692
3,581,127
3,664,333
3,741,142
3,817,262
3,893,038
2,786,975
2,884,648
2,984,399
3,088,502
3,197,995
2,520,621
2,690,753
2,871,852
3,063,788
3,267,904
2,577,739
2,705,960
2,850,733
3,000,967
3,167,533
2,090,254
2,118,571
2,157,870
2,203,220
2,248,397
2,310,820
2,473,675
2,658,919
2,868,421
3,105,810
1,961,655
2,163,541
2,384,470
2,628,926
2,906,487
What should be investment strategy?
• Risk averse investors should rely on fixed income
investments like fixed deposit or bond fund
– Inflation adjusted after-tax return will be very small
but still you are not incurring loss
• Risk takers can invest in market since the
probability of economy growing below 7% is very
low
– One can expect a return of 10% - 15% during 2012-13
• Long-term investors can try contrarian strategy
• Performance of NIFTY Stocks in pre and post slowdown
Which sector to focus?
• India ignored infrastructure for a long-time
• Next super-growth trigger for India is
infrastructure
• Industries related to infrastructure (steel,
cement, construction, power, etc.) can be
focused
• Growth also brings vibration in the economy
and many other sectors will also benefit
Thank You