The good times have returned. The number of stocks closing at their 52-week highs was 44 this week, with the NSE stock index advancing to a fresh high, the S&P BSE Sensex. The biggest riser was ICICI Bank, up by 10 per cent. The most spectacularly large gainer was Adani Ports & Special Economic Zone, up by 89 per cent. The worst performer was Hindalco, with a decline of 34 per cent in just three days.
Indicators that normally provide some clues about the economy — the amount of gross domestic product growing at an annual rate above 10 per cent, for example — went nowhere in this week’s week. Given that they have been weak, we might assume that the market was influenced by concern that economic growth has slowed. This is almost certainly the case. Stock markets seem to be registering a general expectation that the economy will soften significantly, especially as the prospects for trade get worse and as growth looks highly contingent on imported services — i.e., from the US. For this reason, equity investors seem to be betting on an international trade war. And stock investors like to bet against the government. So a whiff of protectionism can signal an overheating economy.
Keep in mind that the last few weeks have seen immense progress towards reaching a deal on trade. The announcement yesterday by both Donald Trump and Juncker, the president of the European Union, that they would try to reach an agreement came in the wake of an agreement last week on lifting the tariffs between the US and Canada, and as well as a possible accord between the EU and Japan. All of these agreements are sensitively framed with US dependence in mind — in the case of the US, as it depends on Asian markets; in the case of Canada and Japan, as they are dependent on America’s market for a major piece of their economic activity.
Therefore, we might expect any broad global slump to lead stock markets downwards in order to take account of a diminished reliance on foreign markets.
And yet there is good reason to remain sceptical about the market. For a start, we are always wrong when we interpret stock prices. They are based on estimates of future earnings. And right now, all of the estimates are for a gigantic fall in earnings. Forecasts are that gross domestic product will expand by 4 per cent this year and expand by 2 per cent in 2020. But, as I will explain shortly, forecasts are never very accurate. It’s normal for predictions to be wrong.
And so we might observe that a temporary hit to earnings should not disturb the market. The market, like all investments, is a bet that returns will be higher in the future. How much greater? It depends on how rapidly growth in demand and employment are decelerating. What we’re seeing now in the market is a bet that these things are going to happen quickly — and that these things will happen much faster than they did in the boom of recent years.
The broader economy, too, is aware of the profit warning. I myself saw my monthly income squeezed recently. If I had planned to cut my wages, I could have done so immediately. But given that economists are very likely to be wrong in predicting future earnings, there is little risk of me being badly caught out. Meanwhile, businesses have adapted to the new situation. Companies like HCL Technologies, which focuses on small businesses, have seen their turnover rise strongly and they are hiring strongly, and — as Mr Trump emphasised — they are doing so while paying their workers better. So in other ways, the market is right, too: The economic message that the economy is slowing is not yet being received as strongly by corporate America as it ought to be.
But, as I mentioned above, we might also observe that this is not a sign of a strong economy. Quite the contrary: It could be a sign of one of the slowest growth periods in many years. The one plausible explanation for this, we might note, is a surge in consumer savings. We know from recent periods of high inflation that falling prices depress spending. And, as I have noted previously, I don’t see why this should be the case any more. In the few cases when we have experienced deflation in recent years, the distortions have tended to be self-reinforcing, dragging on consumer spending. And while there’s a strong possibility that such distortions are receding, I’m not seeing signs of one in the data.
The World Economic Forum’s latest forecasts — which suggest that the worldwide economy will expand by 3.4 per cent this year — are a result of substantial shifts in forecasts from last year. In its October prediction, the WEF had GDP expanding by 3.7 per cent this year.