Srividhya Sivakumar The ongoing carnage in the stock market has certainly taught us all that managing an equity portfolio is not just about keeping abreast of what's happening in India. It is much more than that; after all, who could have imagined that defaults on mortgage payments in the US could snowball into a global financial crisis of such gargantuan proportions? But if you thought that the Dow's influence on the Sensex is a temporary phenomenon, you could be wrong.
A statistical analysis of monthly returns between stock market indices in India and various global markets over a ten-year period reveals a strengthening relationship between the various markets, especially in the past three years. What is more, of the various markets around the world, it is the US and the emerging markets that have exercised the strongest influence on Indian stock movements. For investors looking to reduce global influences on their portfolio, investing in mid- and small-cap stocks within India may be an option to consider. Strengthening influence While Indian investors may have started tracking the overseas markets actively only over the past couple of years, global linkages between stocks markets were significant, even way back in 2000. In 2001, right after the dotcom bubble burst, the correlation between India's equity market (as represented by MSCI India Index) and world equity markets (as represented by MSCI All-Countries World Index) touched a high of 0.73, from just 0.14 the previous year. A high correlation between the two indices suggests they move in the same direction more often. While the global influence on Indian stocks did moderate over the next three years, the correlation never fell back to the 2000-lows again. Even after foreign institutional investments began to gain traction from 2002-03, the correlation between the two indices remained range-bound at 0.3-0.4 until 2004. It shot up significantly only in 2005 (0.85) and has since remained at high levels. Notably, the same trends hold true even in the Nifty index (which captures indices in local currency terms) in place of MSCI India index (which represents them in dollar terms). While the significant returns in Indian equities in the last two years (2006 and 2007) may have lulled investors into believing that the Indian market was decoupled from rest of the world, its year-to-date meltdown in tandem with the global markets, has demolished the decoupling theory. This suggests that even if most investors had managed to add substantial value to their equity portfolios without keeping tabs on global market events in the past, it may not be possible from here on. Which market to track? With practically every economy now impacted by impending financial armageddon, if you were to closely track the global market events, which markets should you choose? An analysis of the correlation between monthly returns of MSCI India with MSCI's country indices for China, the US, Japan and emerging markets over the past five years reveals that emerging markets (0.77) and China (0.69) exercise a stronger influence on Indian markets. That most hedge funds and global investors apportion a chunk of their investments to emerging markets as a "basket", and not specifically to India or China, may explain this high correlation. However, tracking the US market appears to be even more significant for investors keen to predict market direction. On a year-on-year basis, the MSCI India's correlation with the MSCI US has shot up sharply from just 0.13 in 2004 to 0.90 in 2006. In 2007, when the domestic market was at its peak and the US markets too generated decent returns (as the sub-prime issue had emerged only then), the correlation dropped to 0.59, only to rise again this year. This means that for Indian equities to resume their uptrend, it is imperative that stocks pick up in the US too. What is more, investors looking to reduce downside risk have greater need to track global developments. Strengthening correlation between the various global markets suggests that diversifying overseas may not have helped too much, if you were looking to shield your portfolio from global influences. However, investing in mid-cap stocks may have helped, but only over the long term. Midcaps: safe haven? In the last five years, the Indian mid-cap universe, as represented by the CNX Midcap shared a low correlation (less than 0.20) to world equities and emerging markets. The large cap bellwether Nifty saw a correlation of 0.70 for this period. However, over shorter time-frames of three years to one year, global markets have wielded higher influence on mid-cap stocks. Helped by larger fund flows into the domestic market, while the mid-cap stocks did revel in the bull run, they also suffered sharper reversals than their large-cap peers in the recent fall. This is because, during market falls, investors tend to cash out of the small- and mid-cap stocks first, given the higher volatility that comes with such stocks. If it was one of top performers in the bull run, the Indian market has also been among the worst hit by the global equity meltdown. History shows that there is nothing new in this trend. In all the corrective phases in stocks over the past few years, be it the dotcom crash in 2001, the commodity bubble of 2006 or the present one, the correlation of Indian stocks with world equities has strengthened. Correlations were, in fact, stronger during the corrective phases than during the bull phases (such as the run up before the dotcom burst in 2000-01 or the global market meltdown in May 2006). Predictably, during most corrective phases, a moderation in risk-appetite drives investors and funds out of the emerging markets. While this may be too short a period to judge the extent of influence, the correlation between domestic and global markets peaked (at 0.95-1.0) in July-September of this year, just around the time when we saw the marquee names in the world financial and banking space go belly-up. http://www.thehindubusinessline.com/iw/2008/10/26/stories/2008102650700900.htm Sweet is the remembrance of troubles when you are in safety. --~--~---------~--~----~------------~-------~--~----~ You received this message because you are subscribed to the Google Groups "Kences1" group. To post to this group, send email to [email protected] To unsubscribe from this group, send email to [EMAIL PROTECTED] For more options, visit this group at http://groups.google.com/group/kences1?hl=en -~----------~----~----~----~------~----~------~--~---
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