Keynote Capitals on Sensex and impact of key economy indicators
The Indian stock market has been incessantly correcting over the last ten months or so. We attempted to establish links between the market performance (as captured by movements of the BSE Sensex) and some key indicators such as inflation, money supply, index of industrial production (IIP), GDP, credit growth and interest rates.
The attached note contains our analysis.
Summary of Conclusions
1. The Sensex and the rate of inflation have inverse correlation. The inverse correlation has been amply evidenced during April – October 2007 (declining inflation fuelled the Sensex rally) and during November 2007 – September 2008 (inflation went up and the Sensex gave negative returns).
2. Post October 2008, inflation has started declining, so has the Sensex. A similar trend – of declining inflation, accompanied by a declining Sensex – was witnessed during January 1998 – July 1999 and during January 2001 – July 2002. The returns on the Sensex during these 2 periods, were near their bottoms at the peak of inflation and thereafter the Sensex consolidated for some time.
3. Key fiscal and monetary indicators viz., GDP, IIP, credit growth, interest rates and money supply (M3) all show a strong correlation with the Sensex.
4. Changes in rate of inflation trigger a series of changes in underlying macro-economic indicators. For instance, a drop in inflation eases interest rates and boosts aggregate demand, which in turn, helps industries recover and go for more investments. However, there is a time lag after which markets may consolidate.
5. The Indian economy is currently witnessing falling inflation and falling interest rates. A gradual rise in consumption would help in boosting industrial production, with a time lag of 3-4 quarters, before the latter materializes.
6. Historically, credit growth has immediately responded to liquidity measures such as increase or reduction in CRR, except for a few aberrations. However, industrial production picks up, in response to liquidity measures and interest rate movements, only with a time lag of 3-4 quarters.
7. The RBI has attempted to boost liquidity by slashing CRR twice during the last 2 months. Considering the time lag and the weak consumption demand, we expect the markets to consolidate over the next 3-4 quarters, aided by the southward journey of inflation and declining interest rates.
-contributed by a blogger.
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