August 15, 2012
Eurostat recently reported that Q2 2012 GDP growth was (0.2%) for the entire Eurozone, which was a decline from the 0.0% growth reported in Q1 2012. With the 17 countries that make up the Eurozone accounting for 25% of global GDP, it’s clear that Europe has been an ongoing drag on global growth. Additionally, with the US reporting a deceleration in GDP growth to 1.5% in Q2 2012 a large number of Indian investors are beginning to wonder what a global recession would mean for the Indian economy and Indian stocks.
Before we can determine whether India is headed for a recession, we need to define the meaning of a recession. Many financial journalists and investors mistakenly believe that two negative quarters of GDP growth is the technical definition of recession. I think this rule has become popular because of its simplicity, but that doesn’t make it correct or accurate.
The actual technial definition of a recession as defined by Pami Dua in her paper Business and Growth Rate Cycles in India is the following:
In summary, a decline in GDP is not enough to make a recession call. It has to be coupled with declines in employment, sales and income. Based on Ms. Dua’s research, the Indian economy has only experienced two short recessions, which occurred from March 1991 to September 1991 and from May 1996 to November 1996, since liberalization began in the 90s.
Despite the recent malaise that has negatively impacted the Indian economy, mid-single digit GDP growth can in no way be interpreted as a recession. Interestingly, during the 2008 crisis India didn’t experience a recession either but rather a milder outcome called a slowdown, which is simply a deceleration in growth. There are a number of reasons that have resulted in the recent trend of declining growth including a negative attitude toward foreign retail investment, a persistent budget deficit, poor energy infrastructure and continued price controls on natural gas and coal. Ultimately, the underlying problem remains a failure to continue down the path of economic reforms and greater liberalization. The risk of a further deceleration in growth is very real.
Although the Indian economy hasn’t entered a recession since the 90s there have been four distinct slowdowns – March 2000 to July 2001, April 2004 to October 2004, October 2005 to March 2006 and January 2007 to January 2009 – according to Pami Dua’s research.
The next logical question for investors is what does a slowdown mean for the stock market. In the chart below we can see that in the Spring 2004 slowdown the market was essentially flat and in the Fall 2005 slowdown the market actually rallied 31%. But the the 2008 experience is what should keep you awake at night. From its peak in January 2008 to the low in March 2009, the Sensex lost 61% of its value. Why was there such a huge difference in the performance in the index in 2008 relative to the prior slowdowns?
The answer is that in 2008 there was an unprecedented global contagion. As the crisis progressed, Foreign Institutional Investors were forced to repatriate capital and reduce risk as their domestic economies weakened. With Europe already in a recession and the US economy also slowing, another slowdown in India will likely lead to a similar experience to that of 2008 for Indian stock investors.
Your next question is most likely is India in another slowdown?
Fortunately, for our paid subscribers we track numerous leading, coincident and lagging indicators to constantly stay on top of big macroeconomic developments in the Indian economy. For example, one such indicator we track is the Index of Industrial Production. We can see below that it’s a coincident indicator and basically turned down in terms of y-o-y growth just as the 2008 slowdown began and didn’t turn positive until the slowdown ended. As of June 2012 the y-o-y growth rate in the index was negative (1.8%). Clearly, the IIP is sending a signal that the Indian economy is slowing down along with the global economy. Thus, investors in the Indian stock market need to be aware that there are significant risks ahead.
I’m already preparing my paid subscribers for another potential leg down in the markets. It is precisely this kind of analysis and risk management that I provide to my subscribers on a monthly basis. Furthermore, my investment recommendations for the Indian market are based on stocks and ETFs, which any investor can buy in their brokerage account. I actively choose to minimize excessive risk and don’t utilize leverage or complicated options and futures strategies.
If this kind of high profit/low risk method of investing appeals to you, I highly recommend you check out our subscription options, by clicking on the following link.