The Indian market is currently out of sync with the developed markets but could perhaps be locking in step with it soon. After outperforming most global markets for the better part of the last two years, the Indian stock market is going downhill in 2011 even as developed markets have posted modest gains.
Consider this, the MSCI India Index — an index of key Indian stocks put together by Morgan Stanley — has declined almost 15 per cent since January 2011, even as the MSCI World Index (representing developed markets) gained 4 per cent.
This has resulted in the Indian market's long-standing trend of moving in step with developed markets breaking down. This is evident from the correlation co-efficient — a measure showing the degree of sync between variables — between the MSCI India and MSCI World indices turning deeply negative in the current calendar (at minus 0.85), after being strongly positive for 2009 and most of 2010.
Several factors are attributed to this divergence of ways, the main being the exodus of FII funds from emerging markets like India back to the developed ones.
Concerns about expensive valuations, stubborn inflation and rising interest rates in India combined with improving economic prospects in the developed markets seem to have triggered this shift in allegiance. Lower valuations in the developed markets have also helped their cause.
The last time Indian markets broke away from developed market counterparts was in the fourth quarter of 2007.
The direction though was different then, with us going up and them coming down. While the developed markets had started reacting negatively to the initial tremors of the financial market catastrophe that was to come in 2008, for the Indian markets, it was still the go-go days, with the Sensex touching for the first time the 20,000-mark. The negative correlation then though was much lower (-0.35) than it is now.
Short-lived?
So if other global markets continue to move up over the next couple of years, will India fail to join the party? Not likely, suggests an analysis of correlation data since 2006. Indian and developed markets have moved remarkably in tandem over the past five years, showing in most quarters, a strong positive correlation (between 0.8 and 0.9).
During these years, the instances when the markets moved out of sync have been quite short-lived. For instance, the negative correlation seen in late 2007 turned strongly positive in the immediate next quarter, with Indian markets joining global markets in a free fall.
Sharp decline
Again, Indian markets threatened to chart their own path in the third quarter of 2008. In the midst of the bloodbath, Indian markets seemed to be stabilising for a while. However, this attempt too to break away from the rest of the world failed, with Indian markets joining the global bandwagon, and declining sharply in October 2008.
If the past is any precedent, the current ‘decoupling' should also hopefully be a temporary phase. After valuations in developed countries catch up, Indian bourses may well go back following markets of the developed countries.