“You get recessions, you have stock market declines. If you don't understand that's going to happen, then you're not ready, you won't do well in the markets.” -Peter Lynch
Two Years Ago, We Advised You To Buy The Economic Recovery
Two years ago, with the Covid-19 induced panic in full cry, we had advised those who read this column that “Four times in the last 40 years, a United States recession alongside falling U.S. bond yields and falling oil prices has been followed by a strong economic recovery in India. In fact, India has never witnessed an economic recovery without a U.S. recession preceding it! Now, all three conditions for an Indian economic recovery—a U.S. recession, smashed crude prices, and falling U.S. government bond yields – are in place.”
Now, as pseudo-economics once again takes hold as we emerge from the pandemic, we once again take up our pen to bust popular macroeconomic myths such as when the U.S. Federal Reserve hikes interest rates, the world will come to an end.
As the red chevrons in the chart above show, each of the grey bars (which denote U.S. recessions) is followed by a green bar (which denotes accelerating GDP growth in India).
In other words, within a year of a recession in the U.S., India’s GDP growth begins to accelerate. Sustained periods of strong economic growth in India after a recession in the US have been observed in 1993-97, 2002-2008, 2009-11, and—most recently—the economic growth phase that began in 2021.
Myth #1: Rising Interest Rates Are Bad For Stock Markets
It is but natural that when gross domestic growth accelerates, central bankers start hiking interest rates to take some of the steam out of the economy and thereby dissipate inflationary pressures with the aim of helping the economic growth phase last longer.
The data from the United States and from India clearly shows that interest rate hikes during growth phases help sustain bull markets.
The S&P 500 in the U.S. has averaged a 9% return in the 12 rate-rising cycles since the 1950s. In these 12 rate-rising cycles, the U.S. benchmark index has risen in 11. More recently, the Fed hiked 17 times from mid-2004 to mid-2006. The S&P 500 rose 46% during that period. Even more recently, the Fed hiked nine times from December 2015 to December 2020 (from 0.25% to 2.5%). The index rose nearly 50% in the first two years of this rate hiking cycle.
We looked at repurchase (or repo) rates in India from 2001 to date and identified four periods of rising rates—2003-08, 2009-12, 2013-14, 2017-18. Interestingly, in none of these periods, not even when the repo rate was as high as 9%, did the Nifty Total Return Index or TRI fall; in fact, its return on an annualised basis was very healthy, as shown in this first data table.
Myth #2: High Inflation Is Bad For High-Quality Stocks
Typically, when economic growth is strong, inflationary pressures build up which is why, as mentioned above, central bankers hike rates gradually to defuse these inflationary pressures. However, at such times, pseudo-economists peddle the notion that ‘high inflation is bad for high-quality stocks’. Such a contention is neither supported by data from the real world nor by theory.
As can be seen in the chart above, on all three parameters—PBT margin growth, revenue growth, and share price return—high-quality stocks (i.e., stocks which are part of Marcellus’ Consistent Compounders and Kings of Capital portfolios) significantly outperform the Nifty. Why does this happen? Let’s take two recent examples to illustrate the broader point that high-quality franchises have both greater pricing power (to pass on input price hikes to their customers) and greater ability to manage input cost pressures (by squeezing suppliers and reducing the working capital cycle).
Example 1: Asian Paints
As shown in the table below, over the last four quarters as India has gradually climbed out of the Covid-19 hole, Asian Paints has consistently grown sales and volumes faster than any of its rivals. This is a familiar situation for Asian Paints—over the past 20 years, it has emerged from every exigency—be it the 2008 financial crisis, 2016 demonetisation, 2017 Goods and Services Tax, or 2021 Covid-19—the firm’s ability to manage both supply-side and demand-side shocks is unrivalled.
Example 2: HDFC Bank, Kotak Bank, And Bajaj Finance
Over the past three quarters, these three lenders have grown their loan book 2-3x faster than the broader banking sector. Their faster growth has been aided not just by the drop in their cost of funds (which has allowed them to offer lower-cost loans to their customers) but also by their superior reach and superior balance sheet i.e., stronger Tier-1 capital.
Implication For Investors
Economic recoveries are associated with high-quality companies continuing to outgun their rivals of revenues, profits, and shareholder compounding. Such recoveries also tend to be accompanied by higher rates of inflation, gradually rising interest rates, and generally buoyant stock markets. Our advice to you would be to not let the pseudo-economists rob you of the benefits of the incipient economic recovery in India.
Note: Asian Paints, Berger Paints, HDFC Bank, Kotak Bank, and Bajaj Finance are part of Marcellus Investment Managers’ portfolios. The authors of the note and their families hold these stocks via their investments in Marcellus Investment Managers’ portfolios.
The above material is neither investment research, nor investment advice. Marcellus does not seek payment for or business from this material/email in any shape or form. Marcellus Investment Managers Private Limited (“Marcellus”) is regulated by the Securities and Exchange Board of India (“SEBI”) as a provider of Portfolio Management Services and as an Investment Advisor. Marcellus is also a US Securities & Exchange Commission (“US SEC”) registered Investment Advisor. No content of this publication including the performance related information is verified by SEBI or US SEC. If any recipient or reader of this material is based outside India and USA, please note that Marcellus may not be regulated in such jurisdiction and this material is not a solicitation to use Marcellus’s services. This communication is confidential and privileged and is directed to and for the use of the addressee only. The recipient, if not the addressee, should not use this material if erroneously received, and access and use of this material in any manner by anyone other than the addressee is unauthorized. If you are not the intended recipient, please notify the sender by return email and immediately destroy all copies of this message and any attachments and delete it from your computer system, permanently. No liability whatsoever is assumed by Marcellus as a result of the recipient or any other person relying upon the opinion unless otherwise agreed in writing. The recipient acknowledges that Marcellus may be unable to exercise control or ensure or guarantee the integrity of the text of the material/email message and the text is not warranted as to its completeness and accuracy. The material, names and branding of the investment style do not provide any impression or a claim that these products/strategies achieve the respective objectives. Further, past performance is not indicative of future results. Marcellus and/or its associates, the authors of this material (including their relatives) may have financial interest by way of investments in the companies covered in this material. Marcellus does not receive compensation from the companies for their coverage in this material. Marcellus does not provide any market making service to any company covered in this material. In the past 12 months, Marcellus and its associates have never i) managed or co-managed any public offering of securities; ii) have not offered investment banking or merchant banking or brokerage services; or iii) have received any compensation or other benefits from the company or third party in connection with this coverage. Authors of this material have never served the companies in a capacity of a director, officer or an employee.
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Note On Table 2: Quality here means Marcellus’ Consistent Compounders Portfolio (CCP) and Kings of Capital Portfolio (KCP). **Note: (1) PBT margin and revenue growth data has been taken until Q3 FY22 (December 2021). (2) PBT Margins for all ‘Quality’ companies and Nifty was calculated separately. It was then averaged, and its YoY percentage change was calculated. This percentage change’s median was then calculated across high inflationary periods. (3) Revenues of all ‘Quality’ companies and Nifty was summed up to arrive at one number whose YoY change was then calculated. These changes’ median was calculated across all high inflation periods (when inflation was above 6%). (4) Share price percentage changes YoY were calculated separately for all ‘Quality’ and Nifty stocks, averaged, and then their median across high inflation periods was calculated. *Note - share price returns were calculated until Jan. 31, 2022.
Note On Table 3: Decorative sales growth for Asian Paints, Berger, Indigo and Akzo reflects the standalone sales growth; Decorative sales growth for Kansai is based on broker estimates/management interviews.
Saurabh Mukherjea and Nandita Rajhansa are part of the Investments team in Marcellus Investment Managers.
The views expressed here are those of the authors and do not necessarily represent the views of BloombergQuint or its editorial team.
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