04 – THE ECONOMIC CYCLE – Mastering The Market Cycle

The economy also moves into the long term and short-term cycle as an industry, stock market and everything else moves which are explained further.

Long-Term cycle

We know that the growing economy graph going upwards in the long term but it has short-term ups and downs.

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Long term straight line is made up of small cyclical ups and downs of the economic cycle of recession and recovery, slowdown and prosperity. These are part of any economy.

Everyone gets agree with the above point but we also need to understand that long-term trends also having a cyclical move as same as the short term. Here we also need to put a focus.

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We can see that the GDP of India has moved from US$ 0.04 trillion to US$ 2.72 trillion which shows long-term up moves but if we see shorter-term momentum of growth rate than it shows highly fluctuating with ups & downs.

 When Population growing it will lead to more consumption and that encourages more production. For producing more, companies need more working hours and that will be converted into more GDP.

So, population growth remains key to the growth of an economy. If growth converts to degrowth then economy starting to shrink.

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When the growth of population changes, it affects the GDP growth for a longer period of time. When a child gets born then it takes around 20-22 years for a child to become an employee. Also, migration from other countries replaces the birth rate of the country. Migration from other countries also enhances consumption and productivity which resulted in growth in GDP.

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Another factor that affects GDP growth is productivity. As productive can be raised despite any growth in the population, then GDP also grows or getting slow with the slower or declining in productivity. We have seen the growth of productivity when human labour replaced by machines, new automobiles, electricity, and computer has introduced. But these all have taken decades of time to affect the GDP. So, for the year to year productivity remains steady. This is not a change that will come overnight and disrupt everything rather it will slowly create changes over a long period.

The aspiration to live a better life encourages people to work hard and produce more. Educational people contribute more to the economy but if people do not like to be educated then it will affect negatively the economy. Such negative effects need to be overcome by the migrated.

Technologies that introduce new businesses and replaced the older. Also, it affects employment.

Automation might have an effect on reducing employment, and thus income and consumption will also decline which again affects the GDP growth.

Globalization provides a chance to export to the other economies which enhances the GDP growth. But the impact negative to the economy which only relies on the import from the other economies.

Short-term cycle

We have seen that many factors take time to affect a long-term trend of GDP. Then why short-term fluctuations occur and why we need to focus on it?

There are factors that cause short-term fluctuations in GDP growth. We always need to focus on those factors to get an edge to our investment. The actual investment game is to getting superior returns than average. We should not focus on the correct forecast but should focus on the superior forecast.

Many of the economists extrapolate current trends and publish reports on it. Such information is available with every so that it does not add much value. Also, we do not get superior returns by doing the same what the majority is doing. It is easy to make any forecast on the excel sheet but it is very difficult to keep it near to reality.

Spending patterns of the individual affect the production of the companies and that has an impact on the GDP growth.

Similarly, companies feel that demand remains robust then they keep on producing more and more but what happens when demand does not come. These unsold goods added to the inventories and companies has to cut production until inventory does not come back at a normal level.

Recession in an automobile has impacted the inventories of OEMs

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Few events also affect the performance of GDP such as war, changes in tax rate & trade barriers by government, cartels in the price of commodity, drought, flood, hurricane, and earthquake.

Superior forecast where we identify the deviation from the long-term trend and recent status of it. Identifying such deviation provides us with an edge. But identifying such is not an easy task and not all unconventional deviation also gets correct. We remember people for their correct unconventional prediction but they also have many failed predictions.

These all short-term factors affect GDP growth in a shorter time frame but that also helps us to get an edge into our investment. So that we require to have a keen understanding of all and focus on it for taking benefits.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

The Investor and Inflation

We all have some needs, some desire in life and we work for fulfilling those. But due to Inflation, our purchasing power get reduce which has always remained a serious question for all of us. We all working hard to beat inflation and enhance our purchasing power. We save, we invest money for our future life. The very popular story everywhere at the market prevailing is a common stock investment is a better tool to beat inflation compared to the bond investment. But is it true in all the situations? We know that every-time it is not true; many a time, good stocks do not give a good return compared to the bond. We need to focus on the valuation of the stock and yield available on the bond. It is very much possible that good stocks can be traded a valuation of the great stocks which can be harmful to us to beat the inflation by investing in it at such a valuation. And at such a valuation, investing into the bond becomes a better choice. Good business is not always a good investment.

Common stocks do not have an inheritance feature to always beat inflation. Yes, it is acceptable that stocks have delivered a good return compared to the bond in the past. But for the future, we need to look at the future of the growth of the economy, growth of the corporate earnings, etc.

If we see the growth of Japan then GDP grows at ~3% CAGR since the year 1981 and similarly their stock market also has given a return of 3% CAGR since the year 1981. Nikkei still is not able to break the higher level of the year 1989. So for growth of the investment return, underlying companies/economy also has to grow otherwise we are not able to earn by making an investment.

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When inflation keeps on rising then companies need to bring more capital for growing sales (as the purchasing power of the company reduces) at similar peace. Such a scenario creates difficulties for businesses to survive and grow further. When companies need additional capital to grow similar sales level, then return on incremental capital will reduce, also companies cannot able to put capital to the new projects as old projects require additional capital. This also can enhance a debt level or the external funding to run a business and that can hamper the profitability.

One of the communication company

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We can see that the capital employed of the company is growing at 16% CAGR and sales growing at 8% CAGR. This means for growing a similar business, the company need to make a twice of capital employed. So that company keeps on requiring external funding to grow the business. Here, we can see that company having a negative working capital cycle though the company needs to bring external funding to grow or maintain the business. There is much business which having such problems and those businesses require to have a huge capital to grow and to even maintain the business.

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Hyperinflation stop consumer to buy more and more goods as their purchasing power starts getting reduced. During such time, businesses do not rise a price to overcome the impact of the rising cost of raw material and other utilities. So that hyperinflation can hamper the earning, growth of the companies and which having an adverse impact on the annual investment return during those time period.

Many people make an investment to the gold, real estate, old paintings, old currencies, etc. for beating inflation but such a scenario does not seem to be practical even. Real estate is a hot investment for getting protection against inflation. But if we missed with a location, the price needs to pay, etc then we also do not protect ourselves against inflation by investing in the real estate.

We should not focus on the one and only basket by seeing the huge return in the past. We should focus on the different basket for making an investment. As we have experience in the near past that due to good return from the equities, people have started making an investment into the equities and market got a huge liquidity flow which has bring the market to the record high level. Similarly in the past for the real estate market.

Our investment success does not count by how much % of return, we have made through investment but how much we left after adjusting inflation is considerable. That means if we have earned 20% return on our investment and inflation is 8% then we need to consider our return is 12% after adjusting inflation. And if our investment is not able to generate a positive return after adjusting for the inflation at a longer period of time then that is of no use for us.

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Similar thing with the Indian economy, we also experienced a Current Account Deficit and we have to borrow money for supporting the economy. If the hyperinflationary situation starts prevailing to an economy then it will become difficult for the economy to grow further. We need to bring more fund to just maintain the existing state of living.

Disclosure – Companies mentioned in the article is just for an example & educational purpose. It is not a buy/sell/ hold recommendation. 

Read for more detail: The Intelligent Investor by Benjamin Graham, Jason Zweig