Decoding Technical Recessions: What They Mean for the Economy in Simple Terms

With news around Germany sliding into a Technical recession, here's basic explainer.

Introduction:

Economics can be full of complex terms and ideas that may sound intimidating, but they have a big impact on our daily lives. One such term is a "technical recession." In this blog post, let's break down what technical recessions are, what they mean for the economy, and how they affect us in simpler words.

What is a Technical Recession?

A technical recession happens when the economy of a country goes through a decline for six months in a row. It means that the total value of goods and services produced within the country (Gross Domestic Product or GDP) has shrunk for two consecutive quarters. This shrinkage indicates a decrease in economic activity and overall production.

The Implications:

A technical recession has several effects on both individuals and the economy as a whole. Firstly, people tend to spend less money during a recession. We become more careful with our finances, which leads to a decrease in consumer spending. This reduction in spending affects businesses across various industries, making it harder for them to make profits and potentially leading to job cuts.

Furthermore, a recession often leads to more people losing their jobs. When companies face financial challenges, they may have to let go of employees to save money. This creates hardships for individuals and families, as they struggle with unemployment and less money to spend. As a result, the cycle of reduced spending continues, which further impacts the economy.

The Effects on Businesses:

During a recession, businesses face tough times. With fewer people spending money, companies find it difficult to make enough sales and generate revenue. This decrease in revenue means that businesses have less money to invest in growing their operations, developing new products, or improving their services.

Additionally, companies that rely on borrowing money may face additional challenges during a recession. Lenders become more cautious and tighten their lending rules. This means that businesses find it harder to get loans or access credit, which makes it even more challenging for them to grow or recover during tough economic times.

Government Intervention and Policy:

To counter the negative effects of a recession, governments take action. They introduce measures to boost the economy and help businesses and individuals. These measures can include things like tax cuts or increasing government spending on infrastructure projects. The aim is to encourage spending, build confidence, and motivate businesses to invest and create jobs.

Central banks, which are in charge of managing a country's money supply, also play a role in fighting recessions. They can lower interest rates to encourage people and businesses to borrow and invest. Central banks can also inject money into the economy by buying financial assets from banks. These actions help stimulate economic growth and support businesses and consumers during challenging times.

Conclusion:

Technical recessions, which occur when the economy shrinks for six months in a row, have significant effects on individuals, businesses, and the economy as a whole. Reduced consumer spending, lower profits for companies, increased unemployment, and limited access to credit are some of the consequences we experience during recessions. However, governments and central banks have tools at their disposal to lessen the impact and promote economic recovery.

Understanding technical recessions is important for grasping the overall economic situation. By staying informed about economic indicators and the steps taken to address recessions, we can make better financial decisions and navigate uncertain times with more confidence.

What is India VIX - the volatility indicator?

If you have spend sometime in Stock market, you would have come across India VIX indicator whenever panic strikes. So what does it mean and what it represents?

The Indian Volatility Index in short is referred to as India VIX. As name suggests, this index measures the volatility of the market. Index helps in understanding if the market participants are feeling fearful or complacent about the market in the near term.

It indicates the degree of volatility or fluctuation traders expect over the next 30 days in the Nifty50 Index. India VIX was introduced by the NSE in 2008, but the concept was originally introduced by Chicago Board Options Exchange in 1993.

Expert note - If you are interested in learning the mechanism of calculation, refer to NSE for technical information.

How to interpret India VIX?

Say the India VIX value is 21.88. This means that the traders expect 21.88 per cent volatility for the next 30 days. In other words, traders expect the value of the Nifty to be in a range between +21.88 per cent and -21.88 per cent from the current Nifty value for the next year over the next 30 days.

You can easily understand the importance of India VIX as indicator, when you see the Index over COVID panic start - going up to almost 70.

Use this indicator as one additional guidance tool when trading in India market.

Inverted Yield Curve

One of the finance term which has suddenly gained lot of attention is 'Inverted Yield Curve'. So let's understand what does the Inverted Yield curve mean and what it indicates.

Yield curve is basically graphical representation drawn on expected interest (called yield) to be received on government bond (called as G-Security, Treasury bill, GILT etc) over different maturity period. Under normal situation, you get higher interest on Government bonds carrying longer maturity - which when plotted on graph give you positive slope for the yield curve. It looks something like below: 

Historically, this yield curve has shown inverted or negative slope in the lead up to the recessionary environment or economic slowdown. This generally looks something like below:

What to look out for? : Investors watch parts of the yield curve as recession indicators, primarily the spread between the yield on 2-year to 10-year (2/10) curve Treasury bills. Following graph by Reuters shows the historical recession and inverted yield curve happening very clearly.

CAGR meaning and calculation

CAGR or Compounded Annual Growth Rate refers to the mean annual growth over given period of time. To simply put, it shows the average annual return generated over a period of time thereby smoothing out any spikes or drops from the return over a period.

Let's take an example - you invested in a stock "A" at the beginning of year 2019 at Rs 1,000 and at end of year 2020 it's trading at Rs 500 and now at the end of 2021 its trading at Rs 3,000. How do you compute your average annual return? This is wherein CAGR comes to play, helping you smooth out the fluctuation to show your average return over 2019 to 2021.

How to calculate CAGR?

CAGR can be computed using above formula where in N refers to the number of years. Going back to our previous example, number of year would mean 2 years (2019 starting to 2021 end), Starting Value will be Rs 1,000 and Final Value will be Rs 3,000. Once calculated, you will get return of ~73.2%.

Calculating CAGR using EXCEL - 

You can use Excel's inbuilt formula of RRI. It has three arguments (number of years NPER, present value PV and final value FV).

So to calculate our example, your formula would be =RRI(2,1000,3000)

Always remember, while comparing CAGR between two stocks / investment / any item; numbers of years are equal. Else, you will be comparing apple to oranges.

Debentures explained

Definition: A debenture is defined as an instrument of debt executed by the company representing its obligation to repay the money at a specified rate and with an interest. It is one of the methods of raising the debt capital by company.

A debenture is like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital.

Types: Debentures are primarily issued in two types - Convertible Debenture or Non-Convertible Debenture. Convertible debentures are a type of debentures that can be converted into equity shares of the company. Non-convertible debentures are defined as the type of debentures that cannot be converted into equity shares of the company

Important:

• Convertible debenture carries lower interest rate, as they carry advantage of converting to equity at later stage
• Maturity value of Convertible debenture is dependent on the share price

Dividend dates you must know

Here's quick guide for different dates you would read during Dividend announcement made by the Company and what does it signify -

Dividend Declaration Date : Date on which the dividend is announced by the company

This is the first trigger event, when company announces the dividend. This announcement includes details like dividend amount, total amount of dividend distribution and the record date (will explain this next).

Record Date (Cut-off date) : This is the date by when your name must be on the company's record books as a shareholder to be eligible to receive the dividend

On the dividend declaration day, together with quantum of dividend, the company also announces the Record Date. The record date is the date to simply put date on which final list of shareholder eligible for dividend would freeze. So if you want to be eligible for dividend, your name should be present on the company’s list of shareholders i.e. record book, by this date.

Shareholders whose name are not registered until this date on the company’s record book will not receive the dividend. 

Ex-Dividend Date : The date before which you must own the stock

The Ex-dividend date is usually two days before the record date. Reason for 2 days is due to the stock settlement time of 2 days followed in India. When you buy a stock, it takes two days (settlement time) before it gets reflected in your demat account. If you buy the stock on or after the Ex-dividend date, stock will not be reflected in your account within Record date and hence you won't get the dividend, instead, the previous owner of stock will get the dividend.

Dividend Payment Date : This is the date when dividend is disbursed to the shareholders

This is the date set by the company on which the dividends are disbursed to the shareholders.

Only those shareholders who bought the stock before the Ex-dividend date and got their name in record book of the company would be entitled to get this dividend. 

So if you are planning to get benefit of Dividend, Ex-dividend date is crucial and you need to make sure, that you buy the stock before stock starts trading as Ex-Dividend in secondary market.

Want to learn about how Dividend yield is calculated? Read here.

Free Cash Flow explained

In simple terms, Free Cash Flow (FCF) refers to the amount of cash generated by the entity after accounting for reinvestment in non-current assets. 

FCF = Cash from Operations [-] Capital Expenditure

Wherein, Cash from Operations = Net Income [+] Non-Cash expense [+] Changes in Net Working Capital. This number can readily be referenced from Cash Flow statement presented by the entity.

Non-Cash expense includes P&L expenses which have not been actually spent in Cash, like - Depreciation, Amortization, Stock based compensation, impairment charges etc.

Working Capital is calculated primarily difference between current asset and current liabilities, like -  Accounts Receivable, Inventory, Accounts Payable, etc.. Change in Net Working capital may be positive or negative number and will need to be added or deducted accordingly

Lot of Equity research report also calculates Levered and Unlevered Free Cash flow. So it's very important to understand the difference between them

Unlevered Free Cash Flow, also called Free Cash Flow to Firm (FCFF)

Levered Free Cash Flow, also called Free Cash Flow to Equity (FCFE)

Main difference between FCF, FCFF and FCFE is with respect to how the interest and debt is treated. Here's quick formula to give an idea on interest / debt treatment.

Free Cash Flow: Includes interest expense, but NOT debt issuances or repayments

Unlevered Free Cash Flow: Excludes interest expense and ALL debt issuances and repayments

Levered Free Cash Flow: Includes interest expense, and mandatory debt repayments

Formula to calculate each:

FCF: Cash Flow from Operations [–] Capital Expenditure

Unlevered Free Cash Flow (or FCFF): Earnings before Interest & Taxes (EBIT) [-] Taxes [+] Non-Cash Adjustments (like Depreciation, amortiztion, stock compensation) [+] Changes in Net Working Capital [–] Capital Expenditure

Levered Free Cash Flow (or FCFE): Net Income [+] Non-Cash Adjustments [+] Changes in Net Working Capital [–] Capital Expenditure [–] Debt Repayments

Note - as we started FCFE from Net Income, tax impact on debt repayment should be adjusted to arrive at more accurate number.

Unlevered free cash flow or FCFF is mostly used while doing discounted cash flow analysis