GDP Growth vs Stock Market Returns

Discussion in 'Ask A Query About Your Stock Picks And Portfolio' started by Riya Mazomdaar Investor, Oct 7, 2017.

  1. Riya Mazomdaar Investor

    Riya Mazomdaar Investor New Member

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    This post is to primarily study the relation between GDP growth and stock market returns. In the long run, does the stock market return equal (or be close to) the GDP growth rate? Also, do developed markets give lower returns than emerging markets? We will use statistical data and not qualitative aspects like infrastructure, supply of labour and capital, etc (Developed markets have far more vibrant capital markets which make it easy to raise capital).

    India is viewed as one of the major emerging economies with high potential to grow its GDP sustained over a long period of time. Post 1991, India has attracted a lot of foreign investment due to various factors such as demographic advantage (young working population), resources and political stability. Indian investors are now blindly bullish on the Indian markets with the following words on every investor’s lips:

    Look at the opportunity size, Look at the 140 Crore population, India will post double digit growth for a long time

    [​IMG]

    We are not here to debate on GDP or the growth rate of GDP. It is beyond our capabilities to forecast a 2 trillion dollar economy’s growth over the next 20-30 years. To start off with, we look at Sensex’s performance since its inception:

    [​IMG]

    This is the Sensex chart since its inception. In 1979, the Sensex value was 100 and today it is upwards of 30,000. Lets breakdown the Sensex performance to pre-1991 and post-1991.

    [​IMG]

    Pre-1991 the Sensex went up from 100 to 2,000 in 12 years! Giving a CAGR of 28.36% p.a. and post the “Big-bang” economic reforms of 1991, the Sensex has gone up from 2,000 to 32,000 in 25 years, thus delivering a CAGR of 11.73%. But did the rapid growth of the Indian economy post 1991 slowed down the equity market returns? The GDP growth rate of India has averaged ~ 6% to 7% p.a. since 1991 up from the 4% p.a. average before the economic reforms of 1991. Now we look at the Dow Jones chart from 1991 to 2017:

    [​IMG]

    The Dow Jones index has delivered a CAGR of 8.1% p.a. over the last 25 years and in this period the USA GDP has hardly grown above 4% p.a. with the average being below 3% p.a.

    [​IMG]

    Lets go back to 1991, if you were an investor back then and had to make a 25 year investment in INR terms (ignore the investment regulations for once). Then would you have been better buying the Dow Jones in INR in 1991 or the Sensex would have been a better investment in terms of returns?

    [​IMG]

    Investing in the Dow Jones index would have yielded better returns because of a depreciating rupee coupled with a growing Dow Jones. Inflation in India is higher (Averaging 6% to 7% p.a. since 1991) against the 3% average inflation in USA. Thus, on an inflation adjusted basis the out-performance of the USA equity markets even greater.

    (Figures used in this computation are taken from historical data available through various sources, the accuracy of the data is not guaranteed. There will be 50 to 150 bps difference in computation depending on the source of historical data.)

    To conclude, the higher GDP growth rate has not translated into higher returns through equity markets. We are not being pessimistic on the potential of returns from Indian equities but assuming sustained higher returns than the global average can be a folly on an investor’s part. The risk premium being paid by the investors is very high and may not be justified in the long run.

    The Indian markets are at a crucial juncture: Markets at a Crucial Juncture

    Ultimately, investments in equities are driven by greed and fear. The current sentiment is that of greed and the fear of missing out and investors should be careful about blindly investing in businesses they don’t understand and should definitely not overpay for what they own. Individual stocks can definitely out perform the broader markets (as visible from the last 10 years performance) and that is what our research services are focused on.

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