X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Does Sensex trace GDP growth? - Views on News from Equitymaster
 
 
  • PRINT
  • E-MAIL
  • FEEDBACK
  • A  A  A
  • Mar 30, 2005

    Does Sensex trace GDP growth?

    The Sensex is currently hovering at 6,400 levels at the end of FY05. Where will it be four years down the line i.e. FY09? The answer is over 10,000 (10,071 to be precise)! It is not rocket science, but a simple mathematical calculation. But how easy is that?

    Assume that the Indian economy will grow by 12% every year (to make it clear, this is nominal growth and not real growth. If the nominal growth is 12% and if average inflation during the fiscal was say, 5%, then the real rate of GDP growth is 7% (12 minus 5). Since corporate performance tends to trace GDP growth over the long-term (very important assumption) and 'if' stock market follows suit, compound the current Sensex level by 12% over the next four years and you get the Sensex target for the future!

    But, before you buy this argument, we would like to highlight some pitfalls in these assumptions by presenting the last ten year (FY95-FY04) performance of the Indian economy, the corporates and the Sensex. The objective is to analyse whether there is any co-relation at all. Here are the facts to start of with.

    History speaks for itself…
      FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 CAGR**
    Macro indicators
    Nominal GDP
    growth
    17.4% 17.0% 15.9% 11.8% 15.0% 10.2% 8.0% 9.9% 7.8% 11.7% 11.9%
    Real GDP
    growth
    7.3% 7.3% 7.8% 4.8% 6.5% 6.1% 4.4% 5.8% 4.0% 8.5% 6.1%
    Quantum
    sales growth
    29.6% 23.3% 19.0% (4.3%) 14.2% 23.4% 23.5% 0.7% 11.9% 11.4% 11.9%
    Stock market
    BSE Sensex* (13.7%) 3.3% (0.2%) 15.8% (3.9%) 33.7% (27.9%) (3.7%) (12.1%) 83.4% 6.2%
    BSE-100 (12.2%) (3.5%) (5.5%) 15.9% (2.7%) 75.8% (41.7%) 1.4% (12.5%) 97.6% 7.1%
    BSE-200 NA (6.3%) (4.9%) 14.9% 0.8% 63.9% (41.1%) 7.4% (8.9%) 104.3% 8.0%
    Source: RBI and Equitymaster database.  *as on March 31st  **9yrs

    First the good news. If one takes the last nine years CAGR (compounded annual growth rate) of real GDP and the performance of the BSE Sensex, yes, there is a clear co-relation. While real GDP has grown at 6.1% during this period, the Sensex has also posted similar gains. More importantly, the consolidated net sales of Quantum Universe has risen by 11.9% in the last ten years, which is at par with the nominal GDP growth rate. So yes, the argument is good enough and we concur.

    But look a little deeper and the finer picture emerges. Even as the real GDP growth has been growing at a steady rate on an annual basis in the last ten years, the BSE Sensex has had a very volatile trend. On a year-on-year basis, there seems to be no sync at all between these two factors. However, if one considers the growth in nominal GDP and the corporate performance at the topline level, there is a fair degree of co-relation. This is because, GDP of the economy is the collective output of the agriculture, industrial and services sector, which is fairly represented in the Quantum Universe. Given this backdrop, investors may be better off if some following aspects are borne in mind before venturing into such predictions.

    1. In the long-term, may be: Economy goes through cycles of recovery, peak, slowdown and depression over the longer period of time. Similarly, stock markets also have cycles, depending on how the economy is performing. Therefore, even if India's GDP grows at 12% in one year, the Sensex may not gain a similar percentage during the year. However, the relationship may hold true over the longer-term. Even here, there have been periods in the US economy in the last century wherein there has been a very weak link between economy and stock market performance.

    2. Sensex at over 10,000! So what? Even if the Sensex manages to achieve such targets, what does it mean in the end to the investor? It does not answer which company's share does one buy from a long-term perspective. It is only good if you are a buyer of an index fund and is happy with a 'probable' 12% return per annum. Besides, 'what is hot' and 'what is not' changes over a period of time. The erstwhile bluechips like Century Textiles, Arvind Mills, ACC, Bombay Dyeing are no longer 'preferred' by investors. So, it is pertinant to understand that the benchmark indices only reflect market sentiments and the overall state of the economy. Taking buying/selling decisions just based on an index level is fraught with risks.

    3. There is something called as sentiment: Stock markets are not only influenced by fundamentals but also by sentiments. For instance, lowering of interest rates by the RBI (like until 2004) typically has an impact on the economy with a lag. But the signal that the RBI is reducing interest rates may prop up stockmarkets immediately and stock prices may react much faster. Another example of sentiments playing a key role is the interest level in Indian equites, like say between 2001 to 2003. Even when valuations were extremely attractive, markets lacked in depth because of weak sentiments. There are other risks like stock market scams (we have had three major ones in the last ten years) that impact markets.

    4. What value to assign?: Like the stock price is a factor of EPS and value multiple (called as price to earnings ratio), the index is a function of combined earnings of index stocks multipled by the value multiple. What valuation the Sensex deserves is again subjective. One could take the growth in nominal GDP at 12% as a valuation multiple i.e. P/E, whereas a high risk investor would be willing to pay even 20 times for the combined earnings of Sensex companies. While there is no definite answer to this one, investors have to bear in mind that in a bear market, even if GDP grows, the stock market may not reward the performance. Here the co-relation may turn weaker.

    To conclude, while we believe that fundamentals dictate stock market directions over the longer-term, there are pitfalls in such assumptions, which one has to acknowledge. This is perhaps one of the key reasons why investors could adopt a long-term strategy while investing in stocks. Assuming that a company 'X' is likely to grow earnings at a certain rate, the stock market may take time to reward adequately. But over a period of time, markets will catch up. Patience is the virtue of the game, as far as serious investors are concerned.

     

     

    Equitymaster requests your view! Post a comment on "Does Sensex trace GDP growth?". Click here!

    1 Responses to "Does Sensex trace GDP growth?"

    vibhor jain

    Nov 6, 2015

    jain-Would be good if you could revisit this correlation as economy took 60 years to reach trillion mark, 7 more years to 2 trillion and likely to race to 5 trillion in 5 more years. This will give a realistic empirical peek on effect of growth on Sensex and likely projections as well. Thanks.

    Like 
      
    Equitymaster requests your view! Post a comment on "Does Sensex trace GDP growth?". Click here!
     

    More Views on News

    How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

    Jun 10, 2017

    Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

    Tata Consultancy Services (TCS): A Decent Start to FY17 (Quarterly Results Update - Detailed)

    Jul 14, 2016

    Tata Consultancy Services (TCS) has declared results for the quarter ended June 2016. The company has reported a 3% QoQ increase in consolidated sales while the consolidated net profit was up 0.3% QoQ.

    Tata Motors: A Profitable Fourth Quarter (Quarterly Results Update - Detailed)

    Jul 8, 2016

    Tata Motors Ltd has reported a 19% YoY and 202% YoY growth in sales and net profits for the quarter ended March 2016.

    The Coming Golden Decade of Multibaggers and Megatrends (The 5 Minute Wrapup)

    Jun 23, 2017

    Next batch of multibaggers that you should not miss.

    How To Use Your Credit Card Thoughtfully Post-Demonetisation (Outside View)

    Jun 23, 2017

    PersonalFN provides tips to use your credit card prudently.

    More Views on News

    Most Popular

    Digital Transactions were Growing Faster Before Demonetisation(Vivek Kaul's Diary)

    Jun 12, 2017

    Which brings us back to the basic question, why was demonetisation carried out?

    A Pharma IPO in a Market That Loves IPOs but Hates Pharma(The 5 Minute Wrapup)

    Jun 15, 2017

    Tomorrow comes the IPO of Eris Lifesciences. How will a pharma IPO do in this market?

    Get Ready for Commodity Options!(Daily Profit Hunter)

    Jun 16, 2017

    Commodity options trading is one step closer to reality. Learn how to take advantage of this tremendous opportunity.

    Walter Schloss' Investing Record(Chart Of The Day)

    Jun 17, 2017

    In a market full of one-hit-wonders, this investor obviously had a formula that worked. And through the think-and-thin of the market.

    11 Hidden Costs Associated With Your Home Loan(Outside View)

    Jun 16, 2017

    Various costs associated with a home loan.

    More
    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407
     

    S&P BSE SENSEX


    Jun 23, 2017 (Close)

    MARKET STATS