STANDING TALL – Does SENSEX reflect the trends in the Indian Economy?

The Bombay Stock Exchange stands tall on Dalal Street, smiling, smirking and sometimes sarcastically laughing at its visitors. Everyone wonders what holds the key to making the most out of this institution! The Intelligentsia believes that the Sensitive Index is indeed, sensitive to the trends in the Economy and reflects the health of the industry in particular, and the economy in general.

From the outside, if one looks at the correlation between the GDP Real Growth Rate of the Indian Economy and the annual returns of the Sensex, a 10 yr CAGR (FY95 – FY04) of both turn out to be the same i.e. 6.1%. However, there are years in this decade e.g. ’95, ’97, ’99, ’01 – ’03, when the Sensex posted negative returns and the Real GDP Growth Rate & the Quantum Sales Growth, were positive. The Quantum Sales Growth (Total Sales Growth across industries) also matches the Nominal GDP Growth Rate of 11.9% for this decade. (RBI and Equitymaster Database 31 Mar 2004) But various sectors like Steel, IT & Manufacturing sectors have dominated this growth. Also, political factors e.g. Defeat of NDA & the subsequent coming to power of UPA at the Centre, have contributed to the fluctuations in the market, in a major way.

Aug 04 – May 05
It was heartening to see the bulls rise from 4800 levels in Aug 04 to 12612 (historic high) in May 06, giving almost 200% returns to even an index investor. But looking at this growth in isolation, one is tempted to question the Intelligentsia once again.
· FII Net purchases in the year 2005 has been $10.11 billion (SEBI data 31 Dec 2005) which is the highest ever in any year for the Indian markets. A lot of this investment is unaccounted for and gives rise to infusion of illegal funds.
· Percentage of household savings, which has been invested in the stock market, is less than 1% (Indian Business Insight Database 2006) for India. This is still low as compared to other rising economies where the average is close to 8 - 10%. With more liquidity in the system, markets will tend to reciprocate instantaneously. There has been all round development in urban India – though the same trend cannot be seen in rural areas, where monsoon still decides the fate of our agriculture.
· US Federal Reserve Rates have increased from 3% in June 2005 to 5% at the last hike in May 2006. Institutional Investors look for more comparative opportunities in International markets than intrinsic values of their investments.
· BSE Sectoral Indicies like Auto, Capital Goods, FMCG, Metal and Oil & Gas have given returns of 70.6%, 104.2%, 57.1%, 55.4% and 64.2% in the past 1 yr, as compared to the respective sectoral growths (Q4 FY06) of 14%, 24%, 17%, 18% and 15%. (Industry 2.0.0 June 1 2006)
· Market P/E (1 yr forward multiple) moved from 11 to 19 and settled at 14.6 in May 06. Considering that the IIP (Index for Industrial Production) was 9.5% for last FY and industry growth Qtr on Qtr was around 15%, this seems ok. However, P/E means little as a standalone number and reflects more of economic cycles & market expectations. Market Sentiments on the other hand are the reason for this abnormal jump.

Markets at 10000
Mr. Andy Xie of Morgan Stanley, in an exclusive interview with CNBC TV18 on 24 June 06, says,” The market fundamentals have been exaggerated by liquidity and that markets have entered the bearish phase. With rising inflation, crude oil prices and tightening liquidity, fund managers across the world, who have been in the business of chasing rather than adding value, are going to suffer redemption pressures.”
Adding to this, Mr. Janish Shah (Head – Equity Research), Networth Stockbroking Limited, puts a lower limit to the correction phase. He sees 9600 – 9700 as the sustainable level for the Sensex, which falls perfectly with the valuations and the current market trends. The loss of approx. Rs 8000 crores by Equity oriented Mutual Funds substantiates the stand of the above market analysts. (Business Standard 5 June 2006)
The current fall is a replication of the falls in the market in 1994 and 2004 and should not essentially indicate a declining industry. There is always something more to the market. There is economics, there is reason, there is historic data – but – all it likes to do is simply – “stand tall”.

Reference:
Indian Business Insight Database 2006, Retrieved 29 June 2006 from http://www.ibid.informindia.co.in/results.asp
Monthly Presentation (Equity & Debt) by Prudential ICICI Asset Management Company, Retrieved on 31 May 2006 from http://pruiciciamc.com/pruiciciin/htdocs/reports/Monthly_May06.pdf
RBI and Equitymaster Database, 31 March 2004, Retrieved on 29 June 2006 from http://pruiciciamc.com/pruiciciin/htdocs/reports/Monthly_May06.pdf
Industry Version 2.0.0 2006, “Sectoral Indicies & Returns” Retrieved on 28 June 2006 from http://pruiciciamc.com/pruiciciin/htdocs/reports/Monthly_May06.pdf