There's a reason why the market is obsessed with IIP, interest rates & inflation numbers. Read on to find out why
FOREIGN institutional investors (FIIs), we are told, are shying away from Indian equities. Most headlines blame it on inflation and the fall in index of industrial production (IIP). However, there is no denying that the market is in doldrums, which brings forth the importance of economic indicators in the investment landscape. To be sure, the market may defy the underlying fundamentals in the short term, but it moves in sync with the economy in the long run. That makes a strong case for long-term investors to keep track of some of the key economic indicators. That means apart from gleaning the industry and company news, investors should also devote more time to some numbers that impact the fate of the stock market. Here are a few data points that you should always keep an eye on:
GDP Growth:
This is an all-time favourite of analysts. Simply put, the gross domestic product (GDP) of a nation captures the value of all the goods and services produced in that country in a given year. It comprises consumption, gross investments, government expenditure and net exports (exports minus imports). In simple words, it is a measure of the economic activity in a country. The GDP growth rate indicates the pace at which a country's economy is growing. For example, at a time when the world, especially the developed world, is experiencing anaemic growth of 1-2% year-on-year, the domestic economy is growing at an impressive rate of 8%. India is next only to China, which has clocked a double-digit growth rate. The Reserve Bank of India's (RBI) third quarter review of the macroeconomic and monetary scenario published on January 25, 2011 expects the Indian economy to grow at 8.5% in 2010-11.
But how does it affect you as an investor? Nominal GDP growth has a strong positive correlation with corporate earnings. This means that when the economy grows as a whole, companies will also witness soaring profits. GDP elasticity to corporate earnings in India stands around 1.25%. In other words, for every 100 basis points rise in GDP growth rate, the rate of growth in corporate earnings rises on an average 125 basis points (one percent comprises 100 basis points).
No wonder, global investors tracks this parameter very closely. Investors investing across the world watch this macroeconomic variable first before committing any money to a country. Needless to say, if India maintains the rate of growth of GDP over the next decade, it can expect to become a superpower. And the best way to participate in the growth story is to own Indian equities with a long-term view.
Inflation:
A lot of noise is made over inflation these days. Inflation – a rise in the general price level — is an obvious outcome of economic growth. Inflation numbers offer cues about emerging trends in the economy to the investing community. Inflation eats into the purchasing power of individuals and brings down consumption.
As inflation rises, the interest rates also rise. High interest rates push up the cost of funds for companies and pull down profitability. They also affect the demand for housing and discretionary spends funded by loans. In short, high inflation is not conducive to both economic growth and equity and debt investments. Bond investors don't particularly like the phenomenon of rising inflation. As interest rates rise along with inflation, prices of long-term bonds fall, making bond investors lose their money. In the year to January 15, 2011, the food price index rose 15.57% and the fuel price index climbed 10.87%, according to the latest government data. Food inflation is expected to cool off as rabi crops arrive in the market. Though food inflation is expected to fall, investors should watch out for crude prices. Crude oil comprises a huge chunk of Indian imports and if the prices cross the $100-mark per barrel, it can trigger higher inflation in the economy.
10-Year Yield & Yield Curve:
You normally hear this one from debt fund managers and treasury heads of banks. The debt market tracks the yield at which the 10-year government bond trades. It represents the long-term cost of funds prevailing in the market. Some investors look at the benchmark yields to take cues about valuations in equity markets. In classical thinking, a reciprocal of the bond yield should be the price-to earnings (P/E) ratio of equity index. Put simply, if you divide 100 by the bond yield, you will arrive at a number which should be the index P/E. For example, if the benchmark bond yield is quoting at 8% (100 divided by 8), the Nifty index should quote at 12 times the trailing 12 months' earnings. As the yields fall, the market offers higher valuations multiple and vice versa.
The yield curve comprises the rate of interest payable for borrowing for various tenures — say, from one year to 30 years — by the government. Other things remaining the same, a flat yield curve — when there's not much difference between short-term and long-term interest rates — connotes expectations of a moderate slowdown in the growth in the near future whereas a steep yield curve — low interest rates for short-term and high interest rates for long term borrowings – indicates high expected economic growth.
Index of Industrial Production:
This one captures the status of production in the industrial sector for a given period of time compared to a reference period of time. But many analysts do not consider it to be a good indicator, given the structural issues. Capital goods, a component of IIP, is experiencing extreme volatility and offering a distorted picture for IIP.
Some Other Indicators:
There are many analysts who prefer to look at auto sales numbers. Passenger car sales connote the strength of the 'consumption story' whereas the commercial vehicles sales reflect 'economic growth'. An ear-to-the-ground indicator for the auto industry is the waiting time for the buyer of a car before the car is delivered to him.
The new phone connections data each month talks about the communication revolution in India, leading to opening of new opportunities. Bank credit growth is one more parameter that analysts follow. Higher credit growth indicates a prospering economy. Cement despatches are tracked by analysts to understand the trends in infrastructure.
Data Sources:
Getting the relevant information has become much easier with the advent of internet. RBI's macroeconomic review can be found on its website. The website of the ministry of statistics and programme implementation is also a data treasure. The Clearing Corporation of India also comes out with useful data points about the fixed income market. Industry bodies such as the Society of Indian Automobile Manufacturers (SIAM), Cement Manufacturers' Association (CMA) and Cellular Operators Association of India (COAI) also offer good data points.
A Word Of Caution:
However, never follow these indicators blindly. Investors must understand the seasonal issues that crop up while interpreting the numbers. For example, El Nino — a climatic phenomenon — impacted agricultural output across the world, including India. It was reflected in rising food inflation numbers. One has to look at the base while interpreting the indicator. Again, looking at the number in isolation can lead to incorrect decisions. Keep them at the back of your mind while taking broad calls, but it will be wiser to look at them closely before committing money on specific bets.
