Understand business and market cycles to benefit from them
Since 1991 we had seven bull markets and six bear markets of varying time periods and intensity.
The cycles of expansions are characterised by business optimism and expanding business profitability. Conversely, cycles of contraction are characterised by business pessimism and declining or stagnating business profitability. Markets anticipate these fluctuations and move ahead.
Markets start moving up ahead of a boom phase and continue to expand during the boom phase finally declining sharply or crashing anticipating a sharp slowdown or recession.
Similarly, markets anticipate a recovery and boom and start moving up much ahead of actual economic recovery. From investors’ perspective, the turning points in the business cycles are hugely important. Investors who can anticipate the cyclical swings ahead of the market can make a fortune.
The long cycles
Let us try to get a broad but brief perspective of the cycles in India. In the first three decades following independence - 1950s, 60s and 70s – economic growth was very slow in India.
The economy grew only by an average of 3.5 per cent annually during this period. Private corporate sector was relatively very small and corporate profitability was low. “License- Permit- Quota Raj” and irrational taxation constrained the corporate sector and business profitability. The stock market was very shallow and market returns were less than the inflation rate.
The picture started changing in the 1980s when India had the initial dose of liberalisation and the economy moved to a higher growth trajectory of 5.6 per cent a year. This decade witnessed stock market returns beating inflation and returns from comparable asset classes. In the early 1990s, liberalisation, privatisation and globalisation shifted the economic and business paradigm in India. GDP growth averaged 6.5 per cent during the 25-year period 1991-2016.
This sustained high growth in GDP during the 25 years following the liberalisation initiated in 1991 also led to the impressive growth of the Indian corporate sector. Corporate profitability increased manifold. The net profit of the corporate sector rose from Rs 6,400 crore in 1991 to above Rs 4 lakh crore by 2017. The stock market indices reflected this profitability gains: the Sensex multiplied around 32 times, moving up from around 1,000 in 1991 to above 32,000 presently.
The boom and bear phases
Within these long cycles, the markets went through short periods of sharp upswings and downswings, particularly since 1991. Since 1991 we had seven bull markets and six bear markets of varying time periods and intensity. The bull market of 1991-92 witnessed 260 per cent appreciation in one year. During the long bull market of 2003-07 the index rose impressively from around 2,500 to 2,1000 giving a return of 600 per cent in around 55 months. The bull phase from 2012 to 2015 also gave impressive returns.
The bear phases were also sharp and swift. The 1992-93 crash witnessed a correction of 56 per cent. The tech bubble burst of 2000 led to a bear phase, which lasted three years, up to 2003. The global financial meltdown of 2008, undoubtedly the worst in recent history, shaved of 63 per cent from the Indian markets in 14 months. Some periods were characterised, not by crashes, but by prolonged phase of stagnation and drift. This happened during September 1994 to November 1998 during, which the indices moved only sideways and drifted.
Within these major and longish economic and market cycles there were short bouts of sharp upswings and downswings. But, the important take away is that, over the long run, both the economy moves to higher growth trajectory and the markets move to higher levels. Since 1991 India’s GDP rose 10 times and the market (Sensex) multiplied 32 times.
Market dips provide buying opportunities
The future too will be characterised by economic and market cycles. Looking ahead into the future one can safely predict that India is likely to be one of the fastest growing economies in the world, most likely the fastest growing large economy, for many years to come. NITI Ayog has projected that India would be a $10 trillion economy by 2030.
Many global think-tanks share this view. This is a clear possibility, given India’s favorable demographics, the low base of very low per capita income, the entrepreneurial talent available in the economy and sound macro fundamentals.
By 2030 the Sensex and Nifty would have crossed many milestones, like they did in the past. Long-term investors should have this big picture in mind when they invest.
The movement of the Sensex, from 100 in 1979 to above 32,000 presently, has been dramatic and fascinating. From the perspective of investors, the most important take away is that market dips provided great buying opportunities. Particularly, buying at the market trough, when the economy is on the cusp of a recovery, had been hugely rewarding experiences. But it is difficult to buy at the trough. The second best option is to buy systematically.
India on the cusp of a cyclical recovery
Presently, India is on the cusp of a cyclical recovery. During the last three years growth has been modest and corporate profitability almost stagnant. Even though the growth numbers were good, the economy lacked vigour. Sluggish demand impacted corporate top and bottom lines. Many factors contributed to this sluggish growth phase.
The tight monetary policy following the high inflation of 2013-14, the tight fiscal policy for containing the fiscal deficit, declining exports following the contraction in international trade and recently demonetisation and teething troubles associated with GST impacted growth. Ratio of corporate profits to GDP touched a low of 4 per cent, declining from the historical average of 5.6 per cent. Now the tide is turning. Inflation is at low levels and interest rates have declined sharply. The government is spending heavily on infrastructure. Exports are picking up and India’s credit rating has improved.
India’s ‘twin balance’ sheet problem – high stressed assets of the banking system and the highly leveraged companies – which has been the major macro concern, is getting addressed through the recapitalisation of PSU banks. Once capacity utilisation in the economy improves, private capex will pick up. This will be a key turning point. The market is anticipating this.
We are in a mid-cycle
The market trough was in 2013. Presently, we are in a mid-cycle. No one can correctly predict how long this cycle will last and when it will turn down. We believe that this cycle has a long way to go. Even when it turns, that will be a temporary down turn, before the resumption of the secular bull market driven by the India growth story. As the saying goes, “the best time to invest in the market was yesterday; the second best is today.” Investors should continue to remain invested in quality stocks and good mutual funds and persist with systematic investment while being cautious of the valuations in pockets of mid and small caps.