Stock market and the Economy

A tale of two pictures

illumina8 , issue no. 0002, 12 July 2020

"Markets can remain irrational longer than you can remain solvent"

- John Maynard Keynes

Let us begin by having a look at two exhibits:

Picture 1 – Business Standard Front-page July 11, 2020

Picture 2 - BSE Sensex Apr 1, 2020 to Jun 30, 2020

If you compare the two pictures then the difference is as stark as day and night.

Picture 1 (economy) paints a grim picture of the economy and the effect of the corona pandemic:

  • India’s industrial production contracted for the 3rd consecutive month in May (down 34.7% again after a 57% fall in April)

  • Manufacturing production crashed 39%

  • Mining Output shrank 21%

Picture 2 (Stock market) in contrast paints a very rosy picture

  • Between April 1 and Jun 30 this year the Sensex moved smartly and swiftly from 28265 on April 1 to close at 34915 on Jun 30th

  • This translates to the benchmark gaining 6650 points- a 23.52 % return in just two months (135% annualized gain)

There seems to be little co-relation between the state of the economy and the state of the stock market and the story seems to be the same everywhere. Every major economic indicator is down but the stock market is up.

Plenty has been written on this divergence of the economy and stock market. Here is a fine piece on understanding the pandemic stock market by Nobel laureate Robert J Shiller.

Key Takeaways:

1.   The stock market does not always reflect the true state of health of the underlying economy

2.   A fall in the market is a great time to buy quality scrips at attractive prices.

3.   Markets move up much ahead of the actual recovery or improvements in the underlying economic indicators.

Corollary to point 3, If you decide to wait on the sidelines in the hope of timing the market and investing only when the underlying economic indicators improve then its most likely that you would have “missed the boat”.

Don’t take my word for it. Here’s what Warren Buffett wrote in a seminal article during the 2008 financial crisis:

Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month or a year from now.

What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over’

A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent

Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

Corona is not the first viral pandemic to pull the markets down. There have been other epidemics like Avian Flu, Swine Flu , Ebola among others before.

Here is an excellent piece on world epidemics and stock performance

History tell us that every time after the initial fall, the markets have recovered and gone on to make significant gains. The markets have seen world wars, depression, pandemics, financial crisis.

It has overcome every crisis and went on to scale newer heights giving handsome gains to those who remained invested. But still many many investors chose to take the comfort of group consensus and exited the markets at the first sight of danger.

When the proverbial blood runs on the street, it is then a great opportunity for us to pick up quality business at a significant discount.

During the latest Corona induced market crash, most of the blue chips like ITC, HDFC Bank, Maruti were at 5-year lows. Investors who remembered the history of stock market crashes, made tons of money left behind by those fleeing the markets in panic. Now when the markets are up , some of those who had fled are left with losses and regret.

As George Santayana aptly put it: “ Those who forget the past are condemned to repeat it”

And those who remember will continue to prosper.

Happy Investing !!!