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The Global Market Outlook - How Intricately Are Indian Markets Dependent on the US?

Editor, TRANSFIN
Mar 8, 2021 2:15 PM 3 min read
Editorial

On February 26th 2021, Sensex plunged 1,939 points, its sixth biggest crash of all time by points. In fact, the last two weeks have witnessed a relatively rough trajectory for stocks in the US and consequently in India as well.

Investors believe that there's more to come. The key question remains whether this is a tipping point preceding a major global market crash or just another undulation attributed to post-pandemic vulnerabilities, fiscal renewal measures and a mini tech bubble? 

Let's find out!

The Dual Distress of Inflation and Tech Stock Valuation 

The pandemic-induced economic downturn has put the US Federal Reserve on a mitigating path since last year. Multiple stimulus packages coupled with near-zero interest rates have undoubtedly aided economic recovery. 

So, when Jerome Powell came out in assurance that the Fed would be able to maintain low rates even with potentially higher inflation in the near-term (whose expectation resulted in record-high bond yields in the first place), the outcome that emerged was, perhaps, opposite to what he intended. The investors took his appeals with an ounce of salt thinking of it as disingenuous in the face of inevitability. This led to a heavy sell-off amid a general market disquiet. 

The other end of the US market decline last week is related to the overvaluation of tech stocks. This has been a prominent narrative for a while, based on the assumption that a recovering US economy means rebalancing of capital flows away from tech towards traditional businesses. 

The tech-heavy blue-chip S&P 500 fell by around 5% from its recent record in the last few weeks. Dow Jones is 3.4% below its all-time high and NASDAQ Composite officially entered correction territory (down by nearly 10% from February 12th peak) on Thursday. Tech stocks are also more sensitive to rising bond yields as their values depend largely on growth in future earnings which are deeply discounted when bond yields go up.

Is the Eclipse Over? 

As of today, the sell-off mania has subsided and forward-looking market signs are beginning to emerge. However, if Michael Burry is to be believed, who thinks "stock markets are dancing on a knife's edge", a combination of ongoing speculations and debt could cause a crash imminently. 

What lies at the centre of this debate is whether the  ongoing pandemic is done and dusted with. Even though vaccines  are already being deployed, we are far from being sure. When a variable of such high implication still looms large, market expectations are far from being definitive. 

 

Effect on Indian Markets 

After consistent downturns in the last two weeks, which are believed to be a domino effect from US markets, the Indian stock indices also stabilised yesterday. However, VIX is on the rise (above 25) and Nifty is trading at a 4.3 P/B valuation which makes it vulnerable to market correction in case of a global sell-off again. 

There are, of course, a number of variables in the mix which could upend market equilibrium in any direction. Rising crude oil prices, increasing withdrawal of foreign investments from Indian equity markets and higher domestic CPI and WPI inflation numbers are a few among them. But the biggest chink in the Indian market's armour remains in its susceptibility to the slightest trends in US markets

The Theory of Market Relativity 

It is also important to remember that stock markets are simply a reaction mechanism to larger economic indicators. Even though domestic US policies don't have a political bearing on India, their effect on markets usually trickles down on to us. Dow Jones and BSE Sensex have had a correlation coefficient of 0.64 over the last three years which shows a semi-strong relationship between the two and therefore any diversification strategies in either should be carefully organised. 

In any case, in spite of a prevailing forward outlook, Indian markets are sure to gather correspondingly positive or negative returns based on changes in their US counterparts. Even though an investor's goal is to fetch an ideal risk-return tradeoff, it is impossible for an Indian investor to ignore a variable that is eight times larger than his/her domestic market (Dow Jones amounts to $8.33trn; Sensex amounts to $1.16trn). So trust in God, but tie your Uncle Sam strings first!

FIN.

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