Economic activity is not linear, it is cyclical.

Economic or business cycles are periodic expansions and contractions of economic activity. Thus, there will be periods of expansion of output, employment and price rise followed by periods of contraction of output, employment and change in price level / reduction.

The cycles of expansions are characterised by business optimism and expanding business profitability. Conversely, cycles of contraction are characterised by business pessimism and declining or stagnating business profitability. Markets anticipate these fluctuations and move ahead.

Markets start moving up ahead of a boom phase and continue to expand during the boom phase finally declining sharply or crashing anticipating a sharp slowdown or recession.

Similarly, markets anticipate a recovery and boom and start moving up much ahead of actual economic recovery. From investors’ perspective, the turning points in the business cycles are hugely important.

The India Growth Cycles :

Let us try to get a broad but brief perspective of the cycles in India.

In the first three decades following independence - 1950s, 60s and 70s – economic growth was very slow in India. The economy grew only by an average of 3.5 per cent annually during this period.

Private corporate sector was relatively very small and corporate profitability was low.

“License- Permit- Quota Raj” and irrational taxation constrained the corporate sector and business profitability. The stock market was very shallow and market returns were less than the inflation rate.

The picture started changing in the 1980s when India had the initial dose of liberalisation and the economy moved to a higher growth trajectory of 5.6 per cent a year. This decade witnessed stock market returns beating inflation and returns from comparable asset classes.

In the early 1990s, liberalisation, privatisation and globalisation shifted the economic and business paradigm in India. GDP growth averaged 6.5 per cent during the 25-year period 1991-2016.

This sustained high growth in GDP during the 25years following the liberalisation initiated in 1991 also led to the impressive growth of the Indian corporate sector. Corporate profitability increased manifold. The net profit of the corporate sector rose from Rs 6,400 crore in 1991 to more than Rs 4 lakh crore by 2017. The stock market indices reflected this profitability gains: the Sensex multiplied around 35 times, moving up from around 1,000 in 1991 to above 35,000presently.

The Bull and Bear Market phases :

Within these long business cycles, the markets went through short periodsofsharpupswingsanddownswings,particularlysince1991.

Since 1991 we had seven bull markets and six bear markets of varying time periods and intensity.

The bull market of 1991-92 witnessed 260 per cent appreciation in one year.

During the long bull market of 2003-07 the index rose impressively from around 2,500 to 2,1000 giving a return of 600 per cent in around 55 months.

The bull phase from 2012 to 2015 also gave impressive returns. The bear phases were also sharp and swift.

The 1992-93 crash witnessed a correction of 56 per cent.

The tech bubble burst of 2000 led to a bear phase, which lasted three years, up to 2003.

The global financial meltdown of 2008, undoubtedly the worst in recent history, shaved of 63 per cent from the Indian markets in 14 months.

Some periods were characterised, not by crashes, but by prolonged phase of stagnation and drift.

This happened during September 1994 to November 1998 during, which the indices moved only sideways and drifted. Within these major and longish economic and market cycles there were short bouts of sharp upswings and downswings.

Another theory prevalent wrt the Indian Stock Market is the 8 Year Cycle theory.

An analysis of the structural up and down cycles in the Sensex suggests that every eighth year, the benchmark has declined more than 50 per cent. This trend is evident since 1992. The Sensex fell 56 per cent then, after the excesses of the previous bull run driven by Harshad Mehta. Eight years later, in 2000, there was a 58 per cent crash in the Sensex, when the dot-com bubble burst. In 2008, the sub-prime crisis caused a market meltdown that dragged the Sensex 62 per cent lower in one of the most intense sell-offs in recent times.

However the year 2016, the next in the ongoing eight-year cycle for bear markets, the Sensex was only marginally down from the peak.

The structural upmove in the Sensex is not impacted as long as the decline halts at 30 per cent correction from the peak. The sharp and short correction in 2004 dragged the Sensex down 32 per cent, but the recovery was swift. Similar was the case in 2006, when the decline halted after a 30 per cent fall from the peak. In other words, in 2016 also, the situation was salvaged as the Sensex formed a bottom much above the 30% fall.

If we look at the past bull and bear cycles in the Sensex, bear markets could be of two kinds. One where the decline in prices is not too steep but the market moves sideways for an extended period without yielding any gains. For instance, between November 1988 and March 1990, the Sensex lost only 15 per cent. But the market just continued in a trading band for 16 months. A similar movement was observed between November 2010 and December 2011, when the loss in the Sensex was only 28 percent.

The second type of bear market is more vicious and can cause a decline of more than 50 per cent from the peak. Such declines, however, take a shorter time to complete. For instance, the 2008 bearmarkettookjust13monthstoend.The1992fallwascompleted in12months,andtheSensexdeclined56percentinthisperiod.

But, the important take away is that, over the long run, both the economy moved to a higher growth trajectory and the markets move to higher levels.

Since 1991, India’s GDP rose 10 times, i.e. from $ 279 Billion to $ 2.85Trillion currently but the Sensex multiplied 35 times from the 1000 levels to 35500 level now.

Hence, Market dips provide buying opportunities for the long term investor.

The future

The future too will be characterised by economic and market cycles. Looking ahead into the future one can safely predict that India is likely to be one of the fastest growing economies in the world, most likely the fastest growing large economy, for many years to come.

The India Story

NITI Aayog has projected that India would be a $10 trillion economy by 2030. Many global think-tanks share this view. This is a clear possibility, given India’s favorable demographics, the low base of very low per capita income, the entrepreneurial talent available in the economy and sound macro fundamentals.

By 2030 the Sensex and Nifty would have crossed many milestones, like they did in the past.

However, another factor on everyone’s mind is the approaching General Election in 2019 and the expected volatility in the market.

A study on the market behavior during 12 months before & after Elections since 1984 clearly shows that the Elections have virtually no bearing on the market irrespective of the party forming the government. The market has unilaterally grown by an average of 21% before elections & 41% after elections since 1984 as can be seen in the below table.

Long-term investors should have this big picture in mind when they invest. The movement of the Sensex, from 100 in 1979 to above 35,000 presently, has been dramatic and fascinating. From the perspective of investors, the most important take away is that market dips provided great buying opportunities. Particularly, buying at the market trough, when the economy is on the cusp of a recovery, had been hugely rewarding experiences. But it is difficult to buy at the trough.

The second best option is to buy systematically.

Present MarketScenario

Presently, India is on the cusp of a cyclical recovery. During the last three years growth has been modest and corporate profitability almost stagnant. Even though the growth numbers were good in phases, the economy lacked vigour. Sluggish demand impacted corporate top and bottom lines. Many factors contributed to this sluggish growth phase.

The tight monetary policy following the high inflation of 2013-14, the tight fiscal policy for containing the fiscal deficit, declining exports following the contraction in international trade and recently demonetisation and teething troubles associated with GST impacted growth.

Ratio of corporate profits to GDP touched a low of 2.9 per cent, declining from the historical average of 5.6 per cent. Now the tide is turning. Inflation is at low levels and interest rates have declined (though on a slight upswing in recent times). The government is spending heavily on infrastructure. Exports are picking up and India’s credit rating has improved.

India’s ‘twin balance’ sheet problem – high stressed assets of the banking system and the highly leveraged companies – which has been the major macro concern, is getting addressed through the recapitalisation of PSU banks, Indian Bankruptcy code & other residual methods. Rs 83000 cr has already been realized and a further Rs 1 lac crore (Rs 35000 crores from Bhushan Steel alone) is expected to be realized through settlements & NCLT in the current financial year providing the much-needed relief to the Banking sector.

Once capacity utilisation in the economy improves, private capex will pick up. This will be a key turning point. The market is anticipating this.

Along with the spurt in the Government spending on Infrastructure in the recent years and the boom in the Consumption space as is evident from the sales figures of the FMCG sector, Consumer durables and double digit growth in the Auto sector, the Indian economy looks set for a major uptick in the coming years.

OilthoughprovidingaheadwindhasamarginalimpactontheGDP growth but a major impact on sentiment as is evident from the chart below.

We are currently in a mid-cycle. The market trough was in 2013. The earnings are now on an upswing as is outlined below

No one can correctly predict how long this cycle will last and when it will turn down. We believe that this cycle has a long way to go. Even when it turns, that will be a temporary down turn, before the resumption of the secular bull market driven by the India growth story.

As the saying goes, “the best time to invest in the market was yesterday; the second best is today.”

Investors should continue to remain invested in quality stocks and good mutual funds and persist with systematic investment while being cautious of the valuations in pockets of mid and small caps.

Happy Investing!

Stay Blessed Forever!

Sandeep Sahni