Will Rupee determine the fate of your stocks? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Will Rupee determine the fate of your stocks? 

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In this issue:
» A genetic explanation to income differences
» Be prepared for higher electricity bills
» Google indicates BRIC economies losing charm
» Even while markets rise, investors are selling
» ...and more!

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The Indian stock markets seem to be on a shaky note again. Many believe the worst is over and the market is geared for bull rally. Then there are those who opine that high inflation combined with high fiscal and current account deficit would hold back India's growth prospects. And this in turn would affect corporate profitability and market sentiments.

Which school of thought should an investor subscribe to? Which parameter would be the most reliable indicator of how your stocks are likely to perform? We came across an interesting article in the Business Line that drew a link between the direction of the rupee and corporate profits. The financial daily carried out an analysis of quarterly profits of the 1,300 NSE-listed companies for the last five years. The analysis suggested a nearly one-to-one correlation between the direction of the Indian rupee and the trends in corporate profits. In other words, when the rupee falls, corporate profits tend to dip.

Of course, there are several other factors such as interest rates, commodity prices, demand-supply dynamics, etc that affect corporate profitability. But the fact remains that the rupee's movement has a substantial impact on the corporate sector as well as the Indian economy at large. The main reason for this is that India is still heavily dependent on imports compared to several other major economies.

A weak rupee increases the fiscal deficit because of higher subsidies. It widens the current account deficit by inflating the import bill. It leads to higher inflation and impacts savings and investments. This shows how vulnerable our economy is to the rupee-dollar exchange rate.

This correlation could prompt some investors to think that the best way to know where the markets are headed would be to get the direction of the rupee right. If the rupee is set for a sustained appreciation, then dive into stocks right now. Or else, exercise caution.

This theory seems appealing, isn't it? But is it practically possible to guess where the rupee is headed? The answer is no. The fate of our currency is intricately linked to hordes of domestic and global factors. Guessing the direction of the rupee would mean reading the minds of central bankers and policymakers across the world. Moreover, it is important to note that since December 1990, the dollar has appreciated by over 200% against the rupee. Despite this, the BSE-Sensex has managed to shoot up by about 1,850% during the same period.

This leads us to conclude that trying to outguess the rupee's movement would be an effort in the wrong direction. On the contrary, investors must look for great businesses with solid moats that have flourished despite all the problems and hurdles that India faces, including a weak currency.

Do you think investors can make money by guessing the direction of the rupee? Share your comments or post them on our Facebook page / Google+ page

01:30  Chart of the day
Ever since the Indian economy opened up post the 1991 balance of payment crisis, exports have played an increasingly vital role in India's economic growth. Today's chart of the day shows changes in the share of world exports of some major economies from 2000 to 2011. It is evident that the emerging BRIC economies have witnessed a substantial rise in their share of the total world export pie. On the other hand, developed countries have seen their shares decline. The UK has been the biggest loser of the G20 countries.

India and China have seen the share of their exports increasing by over 150% during the said period. But it is worth noting that back in 2000 India accounted for merely 0.7% of the total world exports. As such, the high growth has come on a very low base. Even now, the share is still less than 2%.

Data source: Business Insider

Can a solution to what is predominantly an economic issue be found in the science of genetics? Quite certainly if you believe in the words of a gentleman called Roman Wacziarg. Wacziarg, a professor at a US business school is of the view that there is a link between genetic distance and income differences. Confused? Well, allow us to explain. As per him, a country where the majority of the population is genetically linked to the population of a country where the industrial revolution took place is more likely to be developed than a country where this phenomenon did not take place. So the US which was colonized by Europeans is more developed because Europe is where the industrial revolution had its origins. Countries like India on the other hand were only colonised by the Europeans. But they still have a predominantly Indian population. Therefore, it is not as well developed as the western nations.

However, does all of this mean that India has no chance to bridge the gap in income difference? Certainly not. All India has to do is to make a conscious effort to bring down barriers that attempt to block innovation from spreading through the population. Thus, while Mr Wacziarg's approach could be novel, he seems to be pointing towards the same thing we believe.

"Days of subsides are gone for the power sector." This short, yet powerful statement was made by Mr Jyotiraditya Scindia, India's Power Minister at a recent event. For years now, electricity distribution companies have refrained from hiking prices - being a politically sensitivity issue - despite input costs moving up. The power ministry has realised that providing subsidies in addition to aiding state electricity boards (SEBs) in terms of restructuring their debts has turned out to be a failed model. As such, it now seems that regular hikes in power tariffs are inevitable. This would go with the government's broader plan of curbing the fiscal deficit by phasing out the sops it offers. The 12th plan target is to cut India's subsidy bill to 1.4% of GDP as compared to 2.4% during the previous five-year plan. These moves would have a few key effects. A key one being higher electricity bills for all of us. In addition, this development would bring in higher revenues for SEBs and therefore help improve their financial positions. The same would positively impact power generation companies in the long run as they would receive their dues in a quicker manner.

When Goldman Sachs coined the term 'BRIC' way back in 2001, it caught on like fire. The premise being that the 4 countries notably Brazil, Russia, India and China would grow at a stupendous pace. And then join the US and Japan as the world's biggest economies by 2050. The last decade certainly witnessed BRIC countries growing at a brisk pace. They grew at an average annual pace of 6.6% from 2001 to 2010, almost twice as fast as the global economy, according to the International Monetary Fund (IMF). This in turn led to a flood of money pouring into the equities of these markets. Especially since the developed markets did not have much steam left in them.

But the tide now seems to have turned. BRIC no longer seems to be the apple of the investors' eye. For instance, BRIC searches on Google Inc.'s website fell to a seven-year low in December 2012. At the same time, mutual funds that invest in the biggest emerging markets had outflows in 46 of the past 47 weeks. Inflation is the biggest culprit that has been troubling these economies. In India, high inflation coupled with firm interest rates has played a role in dampening growth. China has put brakes on lending to curb inflation and Brazil is also struggling to tone it down. That said, despite these problems, the fact remains that BRIC nations have still been growing faster than the rich world. So it would not be wise to write them off entirely.

Where is the money from equity markets now going? The redemption at equity mutual funds has witnessed an opposite trend even as the benchmark Indian indices, BSE-Sensex and NSE-Nifty hit 2-year high levels. In the month of January when the indices went up above 3%, large part of investors booked their profits and higher redemptions cropped up. Majority of the investors who had exited their positions were those who were stuck with their investments since a long period. It is pertinent to note that, since May 2012, the redemptions have remained higher than the fresh inflows. However, the withdrawal from the equity schemes seems to have routed to various other investment options like income funds, gilt funds and ETFs schemes. Thus market rally has divested the investments from equity schemes to money market and income funds.

It was a dull week for the world stock markets. Except for China, all the markets ended the week on a negative note. The Dow was down 0.1% during the week. Nonetheless, it was a milestone event for other indices as the NASDAQ index closed at a 12 year high while S&P 500 index closed at a 5 year high. S&P 500 index also posted sixth consecutive weekly gain. The fact that the US trade deficit narrowed in December suggested that the economy is on a recovery path. This instilled a ray of optimism in the markets. Also, fourth quarter earnings have come in stronger than expected. Further, optimism in housing markets and improvement in jobs market also buoyed the sentiments. It may be noted that S&P 500 and NASDAQ closed the week with gains of 0.3% and 0.5%, respectively.

The Indian stock markets were down 1.5% during the week. This was a seventh consecutive session where the markets registered a fall. Disappointing GDP forecast (growth expectation of just 5%) renewed growth concerns and pulled down the markets. With pressure to contain inflation and fiscal deficit still persisting, breaking the 20,000 barrier and sustaining it could be a challenging task in the future.

Amongst the other markets, France was down 3.3% while Brazil was down 3.1% for the week. Germany and Hong Kong were also down 2.3% and 2.1% respectively, during the week.

Data Source: Yahoo Finance

04:50  Weekend investing mantra
"We look for people who have a passion for their business. We frequently buy businesses the owners still manage, where they are monetizing a lifetime of work. They often don't want to sell but need to for estate planning or other reasons." - Warren Buffett

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    Equitymaster requests your view! Post a comment on "Will Rupee determine the fate of your stocks?". Click here!

    3 Responses to "Will Rupee determine the fate of your stocks?"


    Feb 10, 2013

    Dear equity master,
    May I humbly state the following:
    1. Irrespective of any factors known and unknown, the market will be taken to high /higher levels by the institutions and unscrupulous elements to involve a frenzy and attract many innocent small investors.
    2. At any given time of their choice (read greed level), They will dump/exit from stocks and book profit and bring the market to their knees. New reasons will be given for their exit of course in high tech language.
    3. Now after the slaughter is over, and SMALL INVESTOR BOOK THEIR LOSSES they will re enter again giving some brand new logic.
    4. Incidentally rupee will appreciate on their planned entry and will depreciate on their planned exit.
    please advice small investors accordingly. Booking profit at higher levels, u will never become poor/ sucker.
    Mohan Iyer

    Like (1)

    R C Sarangi

    Feb 9, 2013

    I do not agree that higher rupee vis-a-vis US dollar has direct co-relation with Sensex. It id actually inversely related in the short-run. As more dollars chase Indian stocks, more dollar are available in the Indian market and its value tends to drop; and at the same time,stock prices go up. The reverse is true when dollars are pulled out from the stocks sale. It is misleading to say what the article professes in short run, but true in the long run due to macro-economic implication. but everyone is dead in the long run!

    Like (1)

    Prof. N K Jain

    Feb 9, 2013

    In this case rupee movement is made out to be lead indicator. We have so far learn t that stock indices are lead indicator for the economy. This makes rupee to lead economy much ahead. In any case five years study may not give sufficient confidence to predict a long term indicator.

    Like (1)
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