There is an increasing worry that the Dow falling , alongwith other key market indices in the developed and developing world. will have immediate implications for the Nifty as well – and that the Nifty might collapse in sympathy with its US counterparts. Some quick Data analysis shows otherwise.
The above data shows the Dow’s strong momentum since November 2010 (Red Line) where it has had almost a linear trajectory. The Blue Line shows the price ratio between the Dow and the Nifty (prices of Dow divided by Nifty) – as one can see, while the initial few years (2011-2013) did see a sharp rise in favor of the Dow outperforming the Nifty, from then on the relationship has broadly been stable as the ratio fluctuates between 1.9x to 2.5x – Meaning each market tends to underperform the other by about 20%-25% (2.5 divided by 1.9) – At the current juncture, the Dow has outperformed India and is at its historical extremes and one could tactically therefore be SHORT DOW and LONG NIFTY from a 6 month to a year’s perspective (irrespective of what happens in absolute terms to each index).
Chart 2 shows the 6 month return correlation between Nifty and the Dow – there have been long periods where the correlations are negative as well as peak correlations seem to end at about 70% – meaning that one shouldnt take for granted that the next 6 month returns from the Nifty would definitely be in line with what happens to Dow
Interestingly, note that the correlation currently is around its peak and may start dropping if the past is anything to go by! So even if Dow drops, the Indian markets may not respond.
Counterpoint : Dont take Capital Market weakness too seriously!
- Whether the US economy will indeed slow down soon enough is indeed a question – while Brexit, China etc all present challenges, the fact is that the US economy is one of the most resilient and while a slowdown is emphasised even by the Fed Governor last week, it is till continuing to grow at a fast slip as the Nov 23rd Markitt Survey shows – against expectations, the US economy looks like it is indeed still above a 2.5% rate of growth even into November. Therefore there may be a delayed slowdown – and not something that is hitting us immediately.
- Crude and US Yields both showcase the worry that the slowdown is inevitable – whether trading froth or reality one will know with time – but then, both these have a beneficial impact on EM flows as relative attractiveness of the USD suffers. If indeed there is a slowdown in US, while Europe stays relatively stable, funds may move into non US markets ensuring stability for Asia.
- With the INR near its Real Value of about 73.74 and MSCI Asia Ex Japan indices having already fallen sharply, it is likely that the global flow stance inches up a couple of notches to give higher weights to EMs.
- Except US, which trades at a 5% premium to its long term averages, most other large nations’ capital markets are trading just about or below long term Forward PE averages while EMs are down heavily during the calendar year. There is unlikely to be buildup of froth therefore globally and reduces embedded risk
- Finally, while the Chinese have taken a lot of steps earlier to slow down Infra spends and bank credit, the slowdown may have gone too far and it is but a matter of time before stimulus is expanded to push retail consumption sentiment which the Chinese govt seems to be favoring over investment led spending.
The point therefore –
a)The link between Dow Returns and Nifty is not a constant one – Dow , even if it does move down sharply, may not result in the Nifty responding immediately – its response may be determined by a whole lot of other factors and all of them need to be synchronised for the falls to happen.
b)Whether the Dow itself will correct very sharply is itself a question – While a slowdown in the US economy is inevitable, there are many factors – example a delayed but sure backdown on tariff wars, stabilisation of crude around USD 60, a successful Brexit and of course, strength in consumer sentiment responding to all the above – which may all keep the US growth humming well into 2019.
Insights from Prabhudas Lilladher