Use code "UNLOCKVALUE" to get 20% off


Need Help? call us


Equity vs Economy

Blog Details

Equity vs Economy

While the world economy is slipping fast into recession with no signs of immediate improvement, equity markets round the globe have recovered steadfastly to their pre-COVID levels as if nothing has happened that can dampen investor’s sentiments.

To give you a perspective, US is facing its worst times- politically, socially as well as economically. Elections are round the corner with very divided polls, protesters are on the roads rightfully rioting against racism (and few for lifting lockdown), unemployment levels have picked to an all time high levels of 13.3% , more & more businesses are filing for bankruptcies and more than hundred thousands have lost their lives to coronavirus. With all that in the background, S&P 500 has recovered by almost 45% from its March lows to their pre-COVID January highs, inching closer to making newer highs. Interestingly, even the unfavorable socio-political climate and decelerating economy have not dented the confidence of investors in the market. The price-to-earnings ratio of the S&P 500 currently sits at 27 times, the highest since the dotcom bubble. As Morgan Housel puts it, “2020 is a weird and ugly mix of 1918, 1932, 1967, and 1999.”

China has been aiming to acquire strategic and controlling stakes by making large-scale outbound transactions in Europe and the US. They are not just interested in strategic assets like natural resources, they are aiming to move up the economic chain, which makes them a buyer of life science tech, fashion brand-retail, logistics operations, and corporate banking too.

Pandemic + Depression + Riots + Bubble
As for India, indices make no exceptions to their western benchmarks, with a jump of around 37% in less than two-months since bottoming out. So what is it that the market is able to see while economy fails to? The answer lies in the simple fact that equity doesn’t see, it foresees. Market discounts the future. Right or wrong, who’s to say? It is a leading indicator to the lagging GDP numbers. While GDP numbers tell us that how has the economy performed in the last quarter, stock market reflects the consensus of investors about the future growth prospects of publicly traded companies, in ways predicting future revenues (& earnings) which forms large part of country’s GDP. Moreover, companies are global now, so their earnings and stock price shall reflect their multinational performance while GDP number doesn’t.

Aswath Damodaran, a Professor of Finance at the NYU Stern, did some math recently to learn more about this absurd relation. He took quarterly changes in US markets from 1960 to 2020 and regressed it against quarterly GDP figure of US for the same period. The observation was that there is almost zero correlation between the two figures. But he did not stop there and went ahead to regress quarterly index returns with three-quarter ahead GDP figures and found out that they were positively correlated by a 0.28 mark, meaning equity tells a story about the economy- 9 months from now or maybe a year. By that logic, the market isn’t worried about current recession, it is going all guns blazing to discount the future, which of course is hard to predict.

If price of a stock today is moreso a reflection of future earnings, are the valuations justified given that earnings for 2020 as well as 2021 looks washed out? The stocks markets and its participant investors have evolved to not look one year down the line but 2 years, 5 years, 10 years down the line. Some even 30.

But where does one stop? Remember Tesla hitting a valuation greater than Toyota? Well it sells 20 times fewer cars as compared to those sold by Toyota. So what is market doing? It is discounting future, we can’t lay more emphasis on this, can we? Think $100 billions in future. But when? Exactly! That’s hard to tell. Sometimes exuberance gets better of a sound mind. Fear of Missing Out (FOMO) per unit of potential return has picked world over and people rush to join the bandwagon just so that they don’t lose out on those marginal returns. This mentality is often reflected by Robinhood investors in US or Zerodha investors in India. Zero brokerages have lured a lot of unqualified investors who jump the guns on any news but still not quick enough to make any profits. The need is to filter out noise from the news.

The interesting thing to note is not how indices have revived but which sector or which stocks have crusaded that sharp rally. And it goes without saying that the road to recovery was pioneered by tech and pharma stocks. Few essentials play, here or there, but mostly these were two sectors that instilled confidence in the braveheart investors that the worst is behind us and the best is yet to come. While in the recent years, passive investing has embarrassed many active fund manager’s returns, now is the best time in many, many years for investors to pick individual stocks, especially those armed with differentiated insight into earnings. Stocks with strong core earnings growth are available at valuations at historic discounts even after significant out-performance. It’s about time to call the longs!