How Recession Impacts The Indian Stock Market | U.S Recession can Crash Indian Stock Market?

Dear friends, the US has officially entered a technical recession because their GDP fell by 1.6% in the first quarter and 0.6% in the second quarter, and China is also going through an economic slowdown because of their zero COVID policy and the real estate crisis. Russia and Ukraine are fighting each other in a war, which has disrupted the global trade cycle, and currencies across the world are depreciating, including the Indian rupee. So all these events together seem to set up a perfect stage for the global economy to go into a recession. And this recession is believed to be led by the US economy. In this article, we'll try to understand what is happening with the US economy and the global economy, and also how this recession can impact the Indian economy. And most importantly, believe me, or not, there is a way to benefit even from the recession, and how we can benefit from the recession. All right let's get started.

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What is the Recession?

First of all, let's try to understand what is a recession in very simple words, A recession happens when a country's economic activities start to decline and there is a rise in the unemployment rate, and technically a recession has declared when a country's GDP declined for 2 consecutive quarters. And presently, if you see US is the perfect example of a technical recession, where the US GDP has reduced by for 2 consecutive quarters by 1.6% and 0.6%. So now many of you might think that there's a technical recession in the USA, there will be a catastrophe that this and all then let me tell you, the recession is not something new to the US economy, because the USA has experienced more than 30 recessions throughout history and dating back as early as 1857. So to clarify, a recession is not a new monster and history teaches us that a recession is an inevitable part of the economic cycle.

What is happening in the global economy or specifically the US economy?

Now let's try to understand, what is happening in the global economy or specifically the US economy because of which a superpower country like the USA is going to face a recession. There are 2 main reasons for this recession.

1. Overheated Economy

When do we call an economy overheated, when the economy reaches the limits to meet the demands? And some of you might find it harder to understand this statement, so let me simplify it with a simple example. Let's assume that there is a bakery that can manufacture 1000 packets of bread per day but what happens if the demand for bread packets exceeds 1000 packets in a day?  Some of you might think that it's very simple, you hire more people, and you increase the salary of existing workers so that they don't leave the company, and manufacture more bread to meet the demand. Very simple, right? But imagine this happening in every sector and industry in the economy, which means people are earning a lot of money, and industries are earning a lot of profits. And when people have more money, what they will do? They will again go out and buy goods and services; They will buy new shoes, they'll buy new clothes, they'll buy a new television, they'll buy a new car, they'll buy a new house. which means again, the demand for goods and services in that economy is increasing. And now what, do you think happens if the demand for a particular product or service increases, but the supply is limited? What will happen? Automatically, the price will increase which will finally result in high inflation and this is how a simple economy becomes an overheated economy. But the present high inflation situation is not only because of the overheated economy but there is another important reason which is massively fueling the US inflation and that reason is popularly referred to as the "Black Swan Event". 

2. Black Swan Event

In economic terms, a rare and unpredictable event is called a "Black Swan Event".  And the last Black Swan Event was recorded in 2008, which was the housing market crisis but then comes Coronavirus, which was actually not a Black Swan Event; according to the person who coined the term the Black Swan. But still, the COVID-19 pandemic did something which nobody has ever imagined in their wildest dreams. And there is no need to explain what COVID did to the world because we all know it and have gone through it. But the problem here is not the COVID-19 pandemic, the problem lies in how the US government tackled the COVID-19 situation.

So during the COVID pandemic economies all over the world witnessed a slowdown, but the US government decided to print a lot of money to recover from this economic slowdown and the US government ends up printing around $13 trillion. And in order to understand it much better if I tell you the world's biggest war, World War II cost around $5.2 trillion. And this seems nothing in front of the $13 trillion, which the US government printed just like that to come out of an economic slowdown. So this $13 trillion, which was instantly pushed into the economy certainly revived the economic growth and also the stock market, which means right now there was an excess amount of money in the economy; which was reviving the economic growth and also the stock markets. But these acts have consequences and this is not rocket science. Even a guy with common sense can tell you what happens when there is an excess amount of money in the economy. Exactly, it will lead to high inflation because if there is an excess amount of money in the economy, then this excess amount will be spent again on goods and services, which will in turn increase the demand, and as the demand goes on increasing, the price also goes on increasing, which will end up in a situation where we have to face high inflation. 

How Recession Impacts The Indian Stock Market
Source by Google

This is the graph of US inflation, which is at its highest in the last 40 years. So, some of you might have this question or confusion that Are we here to discuss inflation or recession? And the answer is both; Because inflation and recession are closely linked together.

How inflation is triggering a recession?

Now, you might ask the question, how inflation is triggering a recession? So, if you see any country facing high inflation can't survive this inflation for long, so, they have to figure out a way to control this high inflation. And that's where the Central Bank of that particular country comes into the picture and the Central Bank of that country is responsible for controlling inflation. For example, the central bank of the USA is the "Fed" and the central bank of India is "RBI or the Reserve Bank of India", this way every country has their own central bank. Now the 2 questions hit in mind...

1. How the central bank could control inflation? 

They control it; By increasing the interest rate. 

2. What happens when increasing the interest rate? 

It will reduce the liquidity or the flow of money in the economy, which means basically it will reduce the excess amount of money in the economy. 

So, the logic here is pretty straightforward. If the printing of more money in the economy leads to inflation, then reducing that money in the economy should lead to deflation. And in order to reduce liquidity or remove the excess money from the economy, the central bank will increase the interest rates. So what happens when they increase the interest rates? Let's simplify it with an example, let's assume that you wanted to start your own business and for that, you wanted to take a loan from the bank and the bank was ready to give you a loan at a 10% interest rate. But, the central bank suddenly decides to increase the interest rate to control inflation, because of which the bank interest rate will also go up from 10% to 15%. And now the question is, will you take that loan? Maybe the answer might be "No", which means you will not start a business you will not hire people, you will not pay salaries, and you will not sell any goods and services in the economy. As well as you might also not take a loan to buy a house or a car or make any spending on personal loans because the increased interest rate will make the loan EMI more expensive. Now guess what happens when the consumption and the production of goods and services go down? Exactly right, the GDP will decline and when the GDP will decline for 2 consecutive quarters, then that particular economy officially enters a technical recession and this is how the central bank's attempt to control inflation can trigger a recession. And now, you can see that central banks across the globe, including the Fed, the RBI, and many others have started increasing the interest rate massively in order to control inflation. 

How Recession Impacts The Indian Stock Market
Source by Google

If you look at the above graph, you can see a sudden spike in the interest rate in the year 2022, which is almost breaking the 10-year highs. So, these are the reasons why the global economy is expected to go into a recession and this recession can be led by the US economy. So, now comes the real question. 

What will be the impact of the US recession on the Indian economy?

Right now, the Indian economy is much stronger, and also many believe that the US recession will not have any impact on the Indian market. And to be honest, I would like India to become such an economy someday but today India is not an isolated economy. And if there is a recession in the US and Europe, then it will also have an impact on the Indian economy and the Indian market.

If there is an impact, then how much will be this impact?

If you look in Indian exports contributed 21.4% in the years 2021-22 to India's total GDP, and out of this 21.4%, the US contributed around 18% of the total exports. So, according to this data, you can figure out that if there is a recession in the US then it might not have a heavy impact on the Indian economy; But still, an impact will definitely be there and this impact can be on a few particular sectors, which are heavily dependent on the US and Europe markets.

For example, the Indian IT sector contributes more than 8% to India's GDP and employs more than 50 lakh people in India. Indian IT companies are heavily dependent on the US and Europe market which contributes more than 86% of their revenues to the Indian IT firms. So, for that reason, if there is a recession in the US, then it will directly impact the Indian IT sector in turn impacting Indian IT companies like Happiest minds technologies, KPIT technologies, Tata Elxsi, Wipro, TCS, HCL, Infosys, and many more. And along with the IT sector, there are also some other sectors which are mainly manufacturing sectors, could also be impacted, because these sectors also export and cater to the US market and European markets heavily. So now, having understood this whole recession scenario, it's time to move on to the million-dollar question.

How can you benefit from the US recession?

If there is a recession in the US economy, then it will also definitely hit the Indian stock market and a recession in the US not only impacts the exports, it also impacts the investments that are coming from the US market. which can also be an opportunity to buy fundamentally good stocks in the Indian stock market at very low valuations or cheaper prices, and these stocks can be available in 2 categories at that time...

1. Stocks That Are Genuinely Impacted by the US Recession

So, category number one is, those stocks which are genuinely impacted by the US recession, like the IT sector stocks, for example, it could be TCS, Infosys, Happiest Minds Technologies, KPIT Technologies, Tata Elexi, and many more. So, what is happening here is because of the US recession the revenue and the profitability of these companies might get impacted, and in the stock market when a company's profitability or growth gets impacted, the stock price also falls according to that. And if you see right now, the market is already anticipating revenue and profitability impacting IT stocks, because of which the stocks of quality companies like Tata Consultancy Services are already down by 25% from its all-time high price of Rs 4000, and if there will be a recession in the US economy, then the stock price might continue to fall, making it available at even cheaper valuation or lower prices. And right now, you must have realized that these stocks are falling only because of a temporary situation of recession; Because the recession is bound to recover and along with that the quality IT stocks are also bound to recover in the long term. And for that reason, situations like this, when quality stocks are available at cheaper valuations or lower prices might be a good time to invest for the long term. 

2. Stocks That Aren't Impacted by the US Recession

The second category is those stocks that might not be Impacted by the US economy or the US recession, for example, stocks like Hindustan Unilever Limited or DMart earn 100% of their revenue from the Indian market and they are nowhere related to the US recession or the US economy. But still, if there is a recession in the US market, then it will create some kind of panic because of which stocks like Hindustan Unilever Limited or DMart might also fall for no fundamental reason at all. If such kind of a fall in quality stocks, is not related to the quality or the fundamentals of the company and the stock price is falling only because of panic, then such situations can be golden opportunities to invest in such value stocks for the long term. 

And of course, apart from these two categories of stocks, you can also look for opportunities in the US stock market itself because a recession in the American economy can be a golden opportunity because if there is a recession, then the stock market will also be impacted, stocks will go down. And the US stock market has some great companies like Netflix, Amazon, Google, Intel, Walmart, Tesla, and many more. And these companies listed on the American stock market have one of the best businesses in the world. Because if you see no matter how bad is the recession, but ultimately it is believed that the US economy is bound to recover. And as I had mentioned earlier, the US has already recovered from 30 recessions. So this time, it is no different and history might just repeat itself. And for that reason, many great investors believe a recession to be the best time to invest in the stock market, including the legendary investor Warren Buffett, who personally invested billions of dollars in the US stock market during the 2008 recession. And he also has a famous quote about the stock market "Be fearful when others are greedy and be greedy when others are fearful"

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