Over the last decade or so, India has witnessed increased integration with the world economy. In particular, the IT sector and financial sector have grown and much of this growth has been via exports. To get an idea of this increase in exports, consider the following facts: In 2000, India exported $10.7 billion worth of goods to the US. In 2010, this figure jumped to $29.5 billion, an increase of 176%.
At the same time, the stock markets have also opened up to foreign investors. Foreign portfolio investment has been significant in Indian stock markets, and this has had its benefits in terms of higher stock prices and greater market volume. It has also had its drawbacks in terms of higher volatility, especially when foreign funds are withdrawn.
One of the consequences of a more open market and greater foreign portfolio investment has been an increase in the correlation between the Indian stock market and other global stock markets. To test the extent to which this has occurred, we can look at the data.
We look at two major stock market indices, the BSE-Sensex in India and the S&P 500 in the US. We calculate the weekly stock market returns for each year, and then calculate the correlation between stock markets returns of the two indices. The correlation measures how much the two indices move together on weekly basis.
The correlation number lies between -100% and 100%, where -100% is perfect negative correlation, 0% is no correlation, and 100% is perfect positive correlation. In general, we expect stock markets around the world to be positively correlated, so we should expect numbers between 0% and 100%. Here are the results:
The table provides some interesting results. It is quite clear that the correlation between the BSE Sensex and the S&P 500 has increased over the last decade. The correlation is around 40% for the first half of the decade, and is closer to around 60% in the second half of the decade.
We have run these calculations to compare the Indian market with the US market, but it is quite likely that the correlation has also increased with other large markets around the world.
Why has this increase occurred? As we said earlier, as the Indian economy has become more integrated, and as stock markets have become more globally open, it makes sense that markets have become more correlated.
Is this a bad thing? It does have its drawbacks, but perhaps benefits too. Even though the Indian market has become more correlated with the US market, it has still performed much better. Consider this: From the period 2000-2010, the S&P 500 fell by 14%. Over the same period, the BSE Sensex has risen by 279%.
Asad is an Economics Graduate from The London School of Economics who has also been a part of the currency derivatives team of Deutsche Bank in London. Currently pursuing his PhD at the University of California San Diego where he's researching on Algorithmic Trading Strategies, Asad will be your direct line for answers to all the questions you might have on short-term investing. A part of the Equitymaster Team since 2010, Asad has been sharing his knowledge on short term trading strategies with our valued readers, like you, through our various services. In fact, at the last count, his weekly newsletter, Profit Hunter, was being delivered to more than 100,000 smart traders across the world!