Hello, and welcome to this bonus video, my name is Partha Majumdar. During this course, we have discussed various indicators metrics which can help in deciding which whittle fund to invest in. We want to discuss various strategies by which we can decide which mutual funds to invest in. However, there are many other factors which one needs to study to be able to make profits out of mutual fund investments. One such factor is economic climate whether mutual fund investments are made. One of the indicators of the economy is the GDP.
In this video we will see whether there is a relationship between the GDP and the broader markets. Before we go to our topic of discussion, let's quickly discuss what is GDP. I included this just in case the learner is not aware of this particular term. Now, GDP stands for gross domestic product. The gross domestic product measures the value of the economic activity within a country GDP is the sum of the market values of prices of all final goods and services produced in the economy during a period of time. The important word here is final goods and services.
For this discussion, we will consider GDP for a particular country. Now, GDP is measured either by the expenditure approach or by the income approach. In the expenditure approach, we add up all the spending of the final goods and services produced during a period of time. Now, in the income approach, we add up all the earnings during the given period of time by those who produce those outputs. Now, important thing again, I emphasize that GDP only includes final goods and services. final goods and services means that the goods and services which are sold to the final user or the end user, a toothbrush, a pair of contact lenses, the bus right are examples of it.
Goods and services. Whether a sale is made to the final user depends on who buys the product. When you buy a chicken, that's reflected in the GDP when KFC pies chicken, however, it is not counted in the GDP because KFC is not the final consumer. Only after the chicken is cooked and sold by KFC is a transaction counted in GDP. Now we discuss how GDP is computed. First we will discuss how GDP is computed in the expenditure approach.
In the expenditure approach, GDP is equal to the aggregate expenditure. aggregate expenditure is equal to consumption. consumption is when consumers buy products plus investment investments mean when investments are made in the economy, plus government purchases which when government pays purchases, plus net exports, net exports equals two exports minus one So, the formula for GDP is C consumption plus i investments plus g government purchases plus x minus m that is exports minus imports. Next, let's see how GDP is computed in the income approach. Like we discussed earlier, in the expenditure approach, we aggregate all the spending in production in the income approach we aggregate all the incomes arising from that production. So, aggregated expenditure is equal to the GDP is equal to the aggregated income.
So, GDP computed either by the expenditure method or the income approach will be the same value. Let's see how to compute the value added for a new chair. The important thing to note here is that the figures are just for illustration, they should not be taken as the real figures, which may vary in the actual market. Now, these take the stage of production sale value cost of intermediate goods that value added. So, the longer he has a sale value rupees 20 So, he adds to his 20 s value in the making of the chair, the Miller buys the product for rupees 20 and sells for rupees 50. So, he adds a value of rupees 30 the manufacturer why is that rupees 50 and sensor rupees 120 So, he adds a value of rupees 70 and the retailer buys for rupees 120 and sells at rupees 200.
So, he adds 80 rupees value. So, the market value of the final good is rupees 200. So, we see that the value added at all stage sums up to the market value of the final good and the value added of all the final goods sums up to the GDP again to emphasize the point that we take the value added of the final product that is rupees 200. In computing the GDP, we will not take the value added at the intermediate stages. After this short discussion on GDP, let us get out to the topic of our discussion. That is the relationship between GDP and the broader markets.
Now, by broader markets, we mean that the stock market which impacts all mutual funds, whether it's a equity fund or a debt Fund, the general belief is that when the economy is doing well, the stock market will produce good returns. So, normally people will invest in mutual funds in economics, which is doing very well. So, people believe that there is a positive correlation between the real economy and the capital market. However, there is no agreement among the experts as to whether the real economy influences the stock market or the stock market influences the real economy. We will see some rationale towards this. When the stock market does well, it easier to raise equity, business expansion.
If they're able to raise equity, then the economics should improve, this leads to additional investment in the economy. Now, also with the stock market raises general consumers they have more wealth. So there is a wealth effect, which increases the consumption if the consumption increases the economic us where However, when the GDP rises, the investor respond positively and invest more in the stock market, because they think that the rice economy will be good for the stock market. Now, when they invest more in the stock market increases the demand for the stocks, when the demand for the stocks is increased, the price of the stock also rises. This makes the stock market rise. Now, to check whether the general belief is true or false, they just have a look at some data between calendar year 2008 and 2017.
China registered 8.2% GDP compounded annual growth rate. at the same point of time, the Shanghai central sensation, which is the main stock market in China was down by 24.5%. Now, this graph shows that when the GDP is good, it does not necessarily mean that the stock market is doing well. Or when the GDP is not so good. It doesn't mean that the stock market is doing badly. You can think the case of China, India, US and Japan Let's also have a look at some research results done by some experts.
Research by Professor Jay Ritter suggests that there's a negative correlation between economic growth and the stock market returns. He studies the data from 1900 to 2011. In both developed and emerging economies, he's not my professor Jeremy Siegel suggests that there's a negative correlation between economic growth and stock market and he studied data between 1970 and 1997. His case was in all countries except Singapore. When we study the Indian market between calendar year 1991 and 2018, we find that the correlation coefficient is 0.2. Between the real return on Sensex and the India's real GDP growth.
Now, 0.2 coefficient is very small country there's hardly any correlation between the two. That is between the two returns on Sensex and the Indian real GDP. So, the data and the research results seems to suggest that there is no clear connection between the economic growth and the market returns. We try to understand some possible explanations given for this situation. The first possible explanation is that when the growth expectations are very high, investors are so eager to participate in the expected profits of such growth that they largely ignore the price. That is, in this circumstance, they pay a very high price to obtain the stocks or the mutual funds and thus their profits are very low from the returns what they get here don't understand this through an example.
China registered a real GDP growth of 11.6% compounded annual growth rate between calendar year 2002 and 2007 in the end of December 2007 Shanghai sensor and CSI 300 index was that price to equity ratio 42 x. This phase of high growth resulted in high expectation from the investors and the investors are willing to pay a higher price to equity ratio. A decade later, China's real GDP growth in 2017 they accelerated to 6.8%. At this time, the Shanghai sentence CSI 300 index was at price to equity ratio of 16.5 x. This resulted in investors wealth erosion of 24.5%. Another possible explanation is that due to globalization, multinational corporations play a very important role in any economic many corporations derive a good chunk of their profits from the International populations which are not dependent on the domestic operations.
We understand this through an example the performance So the Indian company, Tata Motors is exposed to the operations of jlr Jaguar Land Rover, it's hundred percent subsidiary, which has operations outside India. The profit from jlr forms a large part of the profit pool of the parent company, Tata Motors. However, in this case, the jailer operations outside India will not add to the Indian economy, but its profits contribution will impact the Tata Motors share price. The third possible explanation is that the stock returns are determined by improving values are selected measures for a corporation's performance, like the price to equity ratio or the return on equity. Now, these both reflect on the earnings and the amount of capital contributed by the investor and not by the profits the corporation is making is the economic and other possible explanation is given by Mr. Warren Buffett. So, Warren Buffett thinks that in the long run in a country economic benefits from changing technology accrue to the consumer and not necessarily to the shareholders.
Mr. Warren Buffet cites the examples from car makers, manufacturers of radios, television and aircraft, where the industry has gone a face and have contributed to the economy with the investors the returns are very poor. So, from this discussion, we can conclude that higher economic growth is not a sufficient condition for superior stock market returns. For the investor to make superior returns, due attention has to be paid to the underlying cash flows with the business can generate over a long period of time, sustainable returns ratio of the business and what price one pays to acquire stocks in that particular business. I hope you found this discussion In useful Thank you for listening