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Dow and Sensex: Does the correlation exist? - Views on News from Equitymaster
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  • Feb 8, 2005

    Dow and Sensex: Does the correlation exist?

    Recently, we had conducted a poll on our website, asking readers whether they believed that the correlation between the US and Indian markets still persist. And the response has been mixed (as seen in the chart below). While the majority (52%) has voted that the correlation exists, 44% believe the contrary. While we would have favoured the former had this poll been taken 2 years back, the world has transformed into a changed place during these couple of years (2003 and 2004). Considering this and what we believe might happen in the future, we take sides with those who believe that the correlation 'does not' exist.

    Why we say so?

    The graph below will add more weight to our argument that the correlation amongst the two markets that was witnessed 2 years back, does not seem to exist anymore. The 'blue-box' indicates the period between April 2003 and January 2005. This is the time when the Indian stock markets zoomed up on account of factors like increased optimism of a faster economic growth and low lying interest rates in the US that led to foreign investors setting eyes on higher returns from the emerging markets, including India. And they were not left disappointed!

    The pull factor

    Investors round the globe have come to believe more in the Indian growth story and the sustenance of the same. Beginning the second half of 2003, the performance of the Indian corporate sector has been stellar as well and this has led to increased foreign investment activity in the Indian equity markets. After the record US$ 7 bn net inflows in 2003, the Indian equity markets 'devoured' another US$ 8 bn in 2004. Let us take a look at some reasons why India has emerged as a hot spot for foreign investment in the past two years.

    1. A vibrant and strong entrepreneurial culture seems to be emerging in India, which has become a sort of a competitive advantage for the country. Look at the services sector, which had led the country's GDP growth over the past several years.

    2. The offshore outsourcing story has benefited Indian corporations, especially from industries like software, pharma, auto and ancillaries and textiles. While cost arbitrage has been a major reason for the growth of the offshoring story, these industries now seem to be moving up the value chain by providing high-end services/products to clients. This is likely to help India sustain this competitive advantage.

    3. The strong financial sector continues to be the backbone of India. This is validated by the fact that despite the market crash on 'Black Monday' (May 17 2004), there was no payment crisis. The strength of the country's financial sector can also be gauged from the fact that it had shelved us from the crisis that had engulfed almost all Asian economies during 1997. This strong financial backbone, as a whole, has set a platform to support India's long-term objectives of growth with price stability.

    The push factor

    While the factors mentioned above have pulled the foreign investors towards the Indian capital markets, there has been one major push factor that has aided the process - the relatively low interest rates in the US. As the real interest rates in the US have remained in/near the negative for the past two years, investors have flocked emerging markets in search for higher returns. And they have not been left disappointed either. Now, when there are talks of the US Federal Reserve planning to raise rates at a faster rate, market participants in India have been apprehensive as this might dry up FII inflows. The 'fear factor' was amply witnessed a few days back when, post the release of the minutes of the Fed meeting which indicated that the interest rates are in for a faster rise in the US, the Indian markets came crashing down!


    While the above-mentioned factors have helped the cause of the Indian markets in the past two years, the sustainability remains under question. And with the Fed expected to raise rates faster, who knows we might be in for a 'shock' on the FII front. However, that does not question the validity of the Indian growth story over the long-term.

    We would thus advice investors to stay invested in the Indian growth story for the long-term. But at the same time, investors should not ignore the developments in the global financial markets and corporate actions (like merger and acquisitions, Gillette and P&G being the latest) that could have a material impact on stock markets in India. If one believes that Foreign Institutional Investors (FIIs) are pumping money into India based on the premise that India is one of the fastest growing economies in the world, we would like to bring to investors notice that other emerging markets like Turkey and Peru grew at over 8% in the calendar year 2004!

    The Central Intelligence Agency of the US in the recently released report on National Intelligence Council' 2020 project, states that "the likely emergence of India and China as new major global players is similar to the advent of a united Germany in the 19th century and a powerful United States in the 20th century, and will transform the geopolitical landscape, with impacts potentially as dramatic as those in the previous two centuries." That should sum up the long-term India growth story. Stay invested in it!



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    Aug 18, 2017 12:36 PM