Stock markets: learning from the past

New Covid-19 variants in China, US inflation, high oil prices, geopolitical tensions, all this and more have impacted investor sentiment, with the Sensex and Nifty falling 9 percent in the first six months of 2022.

But instead, this could be a time to accumulate heavily undervalued stocks. A sharp market correction often offers good potential for valuation. How markets reacted to periods of low growth in the past could offer important lessons for the future.

Fiscal 2002-03

The economy slowed sharply in fiscal year 2002-03. But the stock market exited the 2002 calendar year with a profit. The Sensex rose 3.5 percent to 3377.28. These gains continued into 2003, with the Sensex zooming 73 percent to 5838.96. In fact, May-June 2003 was a trough from which the indices continued to rise.

Despite slowing growth, investors remained optimistic about the economy showing healthy growth in the next fiscal year. Investor sentiment was also supported by expectations of solid earnings reports from major companies, which had taken cost-cutting measures during the slump.

While FII’s interest in India was limited during this period and the budget deficit was high at 5.28 percent of GDP in FY03, domestic investors were quite optimistic about the economy.

Fiscal 2008-09

Against the background of the global financial crisis, India’s GDP growth has fallen sharply from 9 percent in the previous fiscal year. In the first two quarters of 2008-09, the economy grew by 7.8 percent and 7.7 percent, respectively, and then declined to 5.8 percent in the third and fourth quarters.

There was a steep correction in the stock market, with the Sensex dropping to 9328 in 2009.

This market contraction was short-lived, however: the markets rose 17 percent through 2010 and Sensex ended the year above 20,000.

Although India was indirectly affected by the subprime crisis (the current account deficit-to-GDP ratio fell to -2.33 percent, the import coverage fell to 9.8 months, the budget deficit increased to 5.84 percent and the FIIs withdrew ₹52,987 crore) India’s GDP held up well at 7.7 percent in CY08. This was a testament to the resilience of the economy and recognizing these FIIs returned in CY09 investing a net amount of ₹83,431 crore.

Tax 2020-21

This was the year Covid-19 put an end to the global economy. Amid widespread lockdowns, the Indian economy shrank by an unprecedented 7.3 percent in fiscal year 2020-21. But stock markets posted their highest annual gains since 2017, with Sensex and Nifty 50 gaining about 16 percent in 2020.

Foreign investors remained optimistic about India with a foreign investment to GDP ratio of 3.01 and an FII inflow of ₹1,70,262 crore in CY20. Import coverage also remained high at 17.4 months. But the budget deficit worsened to 8.89 percent due to higher government spending.

Lesson learned

Market Resilience: Bad news drives the markets down, but eventually the bad news is priced in, stocks become undervalued and stocks start to make gains.

Outperforming global markets: The Indian stock market outperformed the rest of the world over the longer term.

Between July 1991 and May 2014, Indian stock markets rose 14.5 percent per year, while the global stock market index rose 12.7 percent. Similarly, from May 2014 to July 2022, stock markets rose 12.6 percent per year, while the global stock market index gained 10.8 percent.

Long-term stability: There may be short-term market volatility. But in the longer term, the Indian stock market has been steady, stable, uptrend and resilient.

Business Resilience: During difficult phases, companies aggressively look for ways to cut costs and improve business results. They also launch innovative products and services to increase revenue. These measures have long-lasting effects, increasing operational efficiency and sales for years to come.

It is normal to be concerned if growth slows down. However, investors should remember that the Indian stock market has seen much worse. Today, India has emerged as the world’s fastest growing major economy, with GDP growth of 8.7 percent in fiscal year 2021-2022 and projected growth of 7.0-7.2 percent in 2022- 23.

In volatile times, investors should remember that things will improve over time, so reflexive reactions should be avoided. However, they should also be careful about the stocks they invest in, because despite the recovery in the above periods, many stocks have slipped or disappeared from the quoted universe.

Investing in large-cap stocks or large-cap index funds is advisable.

During market declines, stocks, MF units accumulate in a diversified manner and decrease stock allocation in a systematic manner when indices/stocks rise sharply. Investors should also rise in the quality/capitalization curve as the bull run moves into higher and higher stages.

The writer is Head of Retail Research, HDFC Securities

published on

August 21, 2022

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