1. Investment Strategy in Economic Slowdown M S Narasimhan msn@iimb.ernet.in

2. Economic Outlook and Investment Strategy Investment strategies are broadly three kinds – BUY-HOLD-SELL Passive Strategy – Momentum Strategy – Contrarian Strategy or value investing Economic growth is cyclical Is there any correlation between stock market performance and economic growth? Whether we should follow different investment strategies based on economic outlook?

3. Why Economy takes cyclical growth? Capacity building changes supply and demand conditions excess to shortage – Ex. Cement and petro-chemical Innovations take place at intervals and economy gets into accelerated growth following an innovation – Eg. Internet and wireless telecom Government intervention in accelerating growth in one period causes some imbalance in growth and it gets corrected by slowdown Growth is also affected by movement of international capital flow

4. Real GDP Growth Rate (India)

5. Real GDP Growth Rate (US)

6. Stock Market Performance and Economic Growth Whether stock market reflects economic growth? – YES but not significantly – Correlation between Sensex and GDP Growth (1980-2012) : 17.79% ; with one year lag: 8.12% – Correlation between Dow and US GDP Growth (1980-2011) : 32.75%; with one year lag: -17.42% – Economic growth rate is partly influenced by agricultural growth which is not very high

7. GDP and Sensex

8. GDP and Dow

9. Importance of GDP Level YearReal GDP GrowthSensex Growth 2001-02 5.52%-3.75% 2002-03 3.99%-12.12% 2003-04 8.06%83.38% 2004-05 6.97%16.14% 2005-06 9.48%73.73% 2006-07 9.57%15.89% 2007-08 9.32%19.68% 2008-09 6.72%-37.94% 2009-10 8.39%80.54% 2010-11 8.39%10.94% 2011-12 6.48%-10.50%

10. Economic Analysis and Investment Strategy Capital allocation between debt and equity is primarily driven by economic analysis – Previous table shows it doesn’t make sense to invest in stock market during economic slowdown – Investment debt products or fixed deposit makes sense – Challenge: Slow down confirmation comes after six months and by then market is down – Early warnings come around first quarter end – Slow down sustains

11. Momentum Strategy Momentum strategy makes sense during economic boom time Momentum indicator gives buy signal only during economic growth A simple moving average based momentum strategy captures nearly 70% of the high-low difference

12. Contrarian Strategy A strategy that requires one to buy when others are selling and sell when others are buying is contrarian strategy Example: Investing in low P/E and P/B Stocks Investing in industry leader stocks Challenge: Strategy yields maximum profit if investments is made towards end of the slowdown Risk: Timing and waiting period

13. Defensive Strategy Some investors prefer defensive stocks during economic slowdown Stocks in pharmaceutical, food processing/ FMCG, power, stocks with low beta, etc., are generally considered as defensive stock Many times, defensive stock may not decline much but it may not offer positive return during economic slowdown.

14. Investment in Commodities and other Assets Commodities offer positive inflation adjusted return slightly lower than stocks but more than bonds Commodities are negatively correlated with stock market; performs better than stocks during economic slowdown Gold, silver and real-estates are low-risk class assets and hence long-term return is low – Performs better than stocks in economic slowdown

15. Economic Outlook It is difficult to get consensus on future economic outlook Going by recent history, stock market will offer a great return if economic growth rate turns to above 9% – Below 7% will be disaster – Between 7% & 9%, positive but unattractive return – In 2012-13, we will be between 7% & 9% mainly because of agricultural growth and foreign inflow

16. Economic Outlook Whether India will return to 9%+ growth in 2013-14? – Chances are 50%-50% – Hopefully, monsoon will be good after two below- average years – Improvement in global economic outlook – Risk: Political uncertainty – We don’t have any concrete information at this point; one can at best make a guess

17. GDP Growth Estimate Country World GDP Estimate (2013-2017) (in billion dollars) 20132014201520162017 United States 16,221,37816,940,56717,783,56818,705,02819,704,590 China 8,777,2039,641,85110,581,05211,598,97412,713,864 Japan 6,060,8346,207,6656,372,2296,531,0776,695,692 Germany 3,581,1273,664,3333,741,1423,817,2623,893,038 France 2,786,9752,884,6482,984,3993,088,5023,197,995 Brazil 2,520,6212,690,7532,871,8523,063,7883,267,904 U K 2,577,7392,705,9602,850,7333,000,9673,167,533 Italy 2,090,2542,118,5712,157,8702,203,2202,248,397 Russia 2,310,8202,473,6752,658,9192,868,4213,105,810 India 1,961,6552,163,5412,384,4702,628,9262,906,487

18. What should be investment strategy? Risk averse investors should rely on fixed income investments like fixed deposit or bond fund – Inflation adjusted after-tax return will be very small but still you are not incurring loss Risk takers can invest in market since the probability of economy growing below 7% is very low – One can expect a return of 10% - 15% during 2012-13 Long-term investors can try contrarian strategy Performance of NIFTY Stocks in pre and post slowdown

19. Which sector to focus? India ignored infrastructure for a long-time Next super-growth trigger for India is infrastructure Industries related to infrastructure (steel, cement, construction, power, etc.) can be focused Growth also brings vibration in the economy and many other sectors will also benefit

20. Thank You