Nifty 12000? Its (Not) The Economy, St@#$id!

The GDP numbers that came out recently showed the Indian economy grow at a 6 year low- and yet the Nifty has been rising since August 30,2019.

It begs the question- How can Nifty possibly go higher when the Indian economy is in distress? The typical we face from an “industrial” client – When businesses we run are in a tight situation, why would we possibly look at investing! Why are you so optimistic?

Is there a Correlation between GDP Growth and Stock Market Returns?

The correlation between economic growth and stock market returns is a recurring question amongst analysts and investors alike. While many claim that ‘theoretically’ both figures should be the same, others believe that there is no correlation at all. In fact, most studies across the world indicate that there is hardly any correlation between the two!

GDP Growth = Stock Market Returns?

In a theoretical environment stock price increases should exactly match nominal GDP growth. The underlying economy of a country translates into a company’s profits, thus into Earnings per Share (EPS), which eventually determines the price of a company’s stock with constant valuations.  That is, and in theory, and over the long-term, aggregate corporate earnings rise when the economy grows or vice versa.

The global economy has showed us that this is not the case.

Over the last 10 years, India’s GDP growth (in nominal terms) has averaged 13 per cent per annum while the most popular benchmark index in India, Nifty, has seen its earnings grow at a mere 8 per cent per annum. In fact, in nine out of last 10 years, Nifty’s earnings growth has trailed nominal GDP growth by a country mile (the only exception being FY11).

On the other hand, during the 2008 Financial Crisis, stock markets around the world plummeted approximately 40-60%, but of course, the real economy did not shrink ~50% within a few months. The following bull market saw the S&P 500 nearly triple in just 6 years, which is also not reflective of real GDP growth.

When we take the example of China between CY08 to CY17, the country registered 8.2% GDP CAGR (real), but during the same period Shanghai Shenzhen CSI 300 Index was down 24.5%.

Between December 2006 and December 2014, the US benchmark index S&P 500 gained 45%, an average simple growth rate of 5.6%, four times higher than the average growth rate of ~1.5%. and now in the last 4 years, markets have grown at  a much faster clip even in the face of a recession next year and holding near all time highs!

Even on a cross country basis, when we look back over the past 10 years, real GDP growth has been noticeably faster in EM than in DM (4.2% vs 1.1%). However at the same time, real EPS growth has been very similar (-0.6% vs -1.0%). This means that the higher economic growth in EM has failed to translate into the profits growth of listed firms, a slippage that seems to be larger in EM than in DM.

However if we are looking at a longer timeframe we note a more ‘moderate correlation’, albeit still not perfect. Over the past 50 years the US economy expanded at an average compound rate of between 3%-3.5%, however the past 10 years have been significantly slower with average GDP growth less than 1.5% according to data provided by the World Bank.

In a study by UTI MF, when they looked at the correlation of the real return (annual series INR yoy returns) on the Sensex and India’s real GDP growth, from CY 1991 to CY 2018, they obtained a Correlation Coefficient(R) of 0.2 which shows low correlation.

So why are there still such discrepancies between the two key variables GDP growth and stock market returns?

Empirical Evidence

Several studies (Dimson et al. [2002], Ritter [2005]) have examined whether countries with higher long-run real GDP growth also had higher long-run real stock market return. The surprising result was contrary to expectations — the correlation between stock returns and economic growth across countries can be , not marginal but even negative!

Studies done on this subject by Jay Ritter, professor at the University of Florida, confirms this non intuitive connection and suggests that in the long run there has been a negative correlation between economic growth and stock market return in developed as well as in emerging markets. His analysis ran from 1900 through 2011 for developed-markets countries, and 1988 through 2011 for emerging-markets countries. A similar study was done by Jeremy Siegel, Professor of Finance at Wharton School, for the time series between 1970 and 1997, in which he compared the stock returns and economic growth among the developed countries. In his study he found that except for Singapore, over the past 27 years there has been a negative correlation between economic growth and dollar stock returns.

Morgan Stanley and Vanguard analyses show that the average cross-country correlation between long run GDP growth and long-run stock returns has been effectively zero. They show that this counterintuitive result holds across the major equity markets over the past 100 years, as well as across emerging and developed markets over the past several decades.

Why This Counterintuitive Difference

Several factors that cause these discrepancies include but are not limited to:

a) Valuations and Expectations

The market determines the value of a company and various components may influence these valuations, e.g. sentiment, confidence, emotions and so on.

Correlation may be weak when investors have high hopes for the future economic situation, which happens particularly often in periods of fast growth. When growth expectations are very high, investors are so eager to participate in the expected profits of such growth that they largely ignore the price they pay to do so. This attitude leads to overpriced stocks and consequently to low rates of return in the future. For example China registered real GDP growth of 11.6% CAGR between CY02 to CY07, and in end Dec 2007 Shanghai Shenzhen CSI 300 Index P/E was at 42x. A phase of high growth with high expectation resulting in investors willing to pay a higher P/E. However a decade later, China real GDP growth in CY17 decelerated to 6.8% and Index P/E was at 16.5x. This resulted in investor’s wealth erosion of 24.5%.

A similar phenomenon may have occurred during the Post Modi 1.0 bull phase in the broader markets where stocks ran up to 60-80x PE ratios even in  the face of the international slowdown and  lack of earnings pickup – complicated by the Demon and GST events.

Expected economic growth may already be built into the prices and thus reduces future realised returns and run into long bear markets.

Japan is an example of this effect. We see that growth expectations were overly optimistic and 20 years of future growth were already discounted in the 1980s when stock prices grew faster than GDP. In the last two decades, equity performance was negative, while the GDP continued to grow.

b) The GDP number AND the Index-  Uncorrelated by Design

If the difference between the sectoral composition of the economy and stock market is large enough, we cannot expect the EPS growth of listed firms to be highly correlated with GDP growth. For example, if the consumer sector is growing rapidly, but there are no consumer oriented firms in the stock market, then the stock market will not capture this growth.

Taxi aggregators (Ola, Uber), online retailers (Flipkart, Amazon), electronics goods manufacturers, unlisted car manufacturers and hotels hospitals etc – Many of the things that affluent India buys are not represented in the listed market.

This happenes internationally also. For example, Thailand’s exports are 70%-75%% of GDP, but the foreign revenue exposure in the Thai stock market is about 15%. This highlights how the structure of the economy can be very different from the structure of the stock market,

Another way to understand this is the components of Nifty and the return from investing in the underlying 50 stocks, which were in the Nifty 10 years ago – such a portfolio (equal weighted) would give you a return of negative 1 per cent per annum! The other 32 companies – whose 10-year return is below the cost of capital – are from balance sheet heavy sectors like power, construction, metals, telecom, real estate and oil & gas. So changes to the components over time itself can substantially influence the observed returns.

3) Globalisation

The share of corporate profits in GDP can change over time if profits grow faster or more slowly than other components, such as wages or taxes. Economy-wide aggregate profits can therefore move at a different pace from GDP. This is especially relevant in countries that have a large external sector (high export-to-GDP ratio), as corporate profits are driven by global rather than domestic demand.

According to Prof. Siegel, one reason for rates of return on equity not to follow GDP growth may be progressing globalisation and the fact that multinational corporations play an increasingly important role in the economies. A company may produce parts of it business outside of the country it is listed and parts of its profit could be earned outside via overseas sales. Parts of the production process for a multinational firm are not reflected in the country’s GDP.

For example, a substantial part of the performance of Tata Motors was always exposed to operations of JLR, its international subsidiary- this will not add to the Indian economy, but its profit contribution would impact Tata Motor’s share price.

4) Corporate Decisions

As per Jay Ritter, negative correlation also exists because stock returns are determined by improving values of the selected measures of corporations’ performance like P/E and ROE which reflect both i) earnings and ii) the amount of capital contributed by investors, and not by the profits corporations generate in the economy. Therefore if continuous growth is one of the objectives of the firm, it might as well be achieved through reinvestments into negative NPV projects which then achieves economic growth but may not be value-accretive to shareholders.

In simple words, the EPS of a stock market depends not only on the numerator (total profits), but also on the denominator (total number of shares and strategic investing decisions). As both IPOs and stock issuance , in a bull market for instance, dilute the stake of existing shareholders, the actual EPS growth might lag GDP growth even if the total profits growth is in line with GDP growth (a reduction in shares as a result of buybacks may have the opposite effect).

Stock market valuations may also be impacted by a company’s willingness to pay dividends. Not paying a dividend could result in a stock to trade at a discount to its ‘net value’ and vice versa

Mergers and acquisitions often result in significant returns for shareholders, while the impact on the real economy is often less significant.

5) Impact of Central Banks Policies:

In recent times the role of central banks and their monetary policies have significantly impacted stock market returns. The most recent example was the ‘quantitative easing’ policy of the Federal Reserve Bank (FED).

Possible Relevant Factors

So why or how can stock markets rise in slow economic growth or even  a recession?

a) Anticipation effects

Stock markets are forward-looking animals. The stock market may already have priced in the effect of the low growth situation and may begin to anticipate a recovery. For example, stock markets in 2007 and 2008 performed badly in anticipation of a US recession. But, during a long period of economic stagnation, stock markets might do better than expected because they are recovering former losses.

b) Surprise rather than  Fact!

Markets move on expectations and not facts as facts are discounted. Growth surprises, or how a country’s actual GDP growth compares to the prior expectations for growth priced in by financial markets.

Valuations, or the price investors pay for a market’s expected growth at any given time have to be reasonable when growth starts – in which case it is likely that markets will experience superb future returns when the economy rebounds .

c) Profits as a share of GDP

Despite low economic growth, firms have been able to increase profitability by consolidating their market shares or penetrating new markets left vulnerable by weaker competition. Or exercising of the monopoly power of large firms. Example the FAANG phenomenon in the US Therefore, despite relatively weak economic growth, publically listed companies, are still attractive to shareholders because they have retained their profitability, and even increased it faster than GDP growth.

d) Ultra-low interest rates vs Dividend Yields/Future Gains

Ultra low rates happen because investors are pessimistic about the fortunes of the economy. With great uncertainty in the economy, investors are happy to buy bonds for the security they offer – even though they have very poor returns. Because of ultra-low interest rates, shares became relatively more attractive and then a herd phenomenon starts. Investors are willing to buy shares, despite the threat of recession, because they at least have a good yield compared to bonds.

Ironically, the stock market can do relatively well because there is a poor choice of investment opportunities.

e) Selective Share Behavior

It is also worth noting that within the stock market, different firms and sectors will be more affected by bad economic news. For example, after Brexit June 2016, we see a fall in share price for sectors, such as construction and banks. Or the Chinese slowdown impacting Tata JLR and then all its affililates.

However, other sectors may prove more robust. For example, food and drink are less likely to be affected by a recession. Even in times of negative growth, people will still want to buy food and drink.

In  the last two years in  the middle of the crises, the Nifty or the FTSE-100 has done much better than the FTSE-250 or the CNX 500. This is because the larger indices are comprised of giants whose profitability is dependent on strength of their distribution and reach; they are less reliant on pockets of the economy. However, the smaller cousins are composed of smaller companies who are more dependent on the domestic economy, and so are more influenced by prospects of a domestic recession.

f) Globalization to the Rescue

At the current juncture, the resolution  of the US China bit helps the economy two ways – opening up doors to international  and regional trade where Indian exporters also tag along apart from financial services as well as the redirection  of Chinese goods from Asian to western economies relieving pricing pressure on local and small manufacturers. Or a resolution of the Brexit crisis can help exporters to Europe.


In the very near term – say a 6 month to a 1 year scale – negative news can cause negative returns – especially as the media may often throw things out of proportion. But over a slightly longer timeframe of 2-3 years, the pendulum of animal spirits can  often drive markets in a different direction from economic reality. Over much larger timeframes, returns are influenced more by the degree of economic freedom rather than economic growth – which may be a statistical anomaly.

In the blog writers mind, Indian stock markets are as much about Ola as  much about HUL products. Therefore, rather than chasing headlines on economic growth or Nifty , investing money into organisations that are quietly gaining scale and profit and will become leaders is critical to extracting gains.

Our Research teams spend a lot of time digging for gems and we encourage our readers to discuss mid to long term portfolio ideas with us by mailing us at or by visiting us at

Do you know any other factors that cause real GDP growth to differ from stock market returns? Or why the Nifty should rise near term in all this pessimism? Please leave a comment for our community!




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