Economic recession and its impact on stock market returns

Shashikant Singh
/ Categories: Knowledge, Fundamental
Economic recession and its impact on stock market returns

What history suggests about the economic recession and stock market returns.

On Thursday, July 28, 2022, the US economy technically entered into recession. The US economy shrank for a second straight quarter. Gross domestic product (GDP) fell at a 0.9 per cent annualized rate after a 1.6 per cent decline in the first three months of the year. The most common definition of recession requires the GDP of a country to contract in two successive quarters. 

 

The reason for such a drop in economic activity is monetary tightening done by US Fed to rein in inflation in the economy. US Fed has increased Federal Funds Rate (FFR) by 150 bps in the last two meetings. Such aggressive policy was adopted to contain inflation, which was at forty year high. The FFR is the interest rate at which commercial banks in the US borrow from each other overnight. 

 

The US inflation rate was at over 9 per cent last month and the US Fed’s target inflation rate is 2 per cent, which means a gap of 7 per cent points. Historically, every time the Fed has tried to bring down inflation by more than 2 percentage points, the US has witnessed a recession. 

 

Impact on the Indian Economy 

In a globally interconnected world, we cannot remain immune to what is happening in other parts of the world. The impact in the slowdown on world’s largest economy will have an adverse impact on the Indian economy, especially looking at trade relations between India and US. The US surpassed China to become India’s top trading partner in FY 2021-22. Bilateral trade between India and the US stood at USD 119.42 billion, or 11.5 per cent of India’s total trade. Among India’s top 10 trading partners, the US is the only country with which India has a positive trade balance hence slowdown in US might impact the Indian economy more. 

 

Silver lining of global recession 

Those who are more focused on US economic data and the Euro zone data are not much encouraging. Euro zone business activity unexpectedly contracted this month (in July 2022). Its Purchasing Managers’ Index (PMI), an indicator of overall economic health, fell to 49.4 in July from 52.0 in June. A reading below 50 means contraction and above 50 means expansion. This contraction was led by an accelerating decline in manufacturing activities coupled with a near-stalling of service sector growth. 

 

Though Indian economy fundamentals remain strong in terms of corporate leveraging, forex reserves and other macro-economic indicators, it cannot neglect the unrelenting higher crude oil price. India is heavily dependent on imports for its energy requirement, as it imports more than 80 per cent of its crude oil consumption, which might impact its current account deficit. 

 

But the good news is that if major economies of the world go into recession, we might see a plunge in crude oil prices. It has already come down from USD 134 per barrel a few months ago to USD 100 per barrel due to fear of recession. There is an earlier incidence also when we saw crude oil prices buckling under the recession fear. During the great financial crisis (GFC) of 2008-09, brent crude oil collapsed from a high of USD 147 per barrel to nearly USD 35 per barrel. Most recently, during the Covid-19 pandemic, the unthinkable happened and the oil price went into negative. Therefore, if a global slowdown comes, oil prices would surely take a hit which would be highly positive for India. 

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