Decoupling theory again

Buffeted by bad news since late last year, global markets had been falling more less in sync right until mid-June this year. Around June 17, markets around the world made a short-term bottom and rallied fast, right until mid-August. During these two months, the Nifty rose from 15,319 on June 17 to 17,980 on August 18, a rise of 17.7 per cent. At the same time the S&P500, the leading US index, also went up 17.7 per cent. There was no surprise here. Global markets usually move up and down in sync, in response to global macro news. But what happened next was truly stunning and against all conventional assumptions. From 4,305 on August 16, the S&P500 slumped 14.2 per cent to 3,693 by September 23, wiping out almost all the gains of the previous two months. Strikingly, however, the Nifty has dropped from its peak of 17,980 of August 18 by only about 3.6 per cent, over the same period. The Nifty has just performed a stunning feat of a 10.6 per cent outperformance, which has turned an old maxim on its head: “When the US market sneezes, emerging markets catch a cold.”
 

India’s sharp and surprising outperformance has led to a chorus of predictions that India and the developed markets are getting decoupled. In a climate of bubbling patriotism, such ideas catch on fast. We last heard of decoupling in the big boom of 2003-07, when the Indian market rose more sharply than the US market did. However, once this became evident, it soon became the popular view among foreign institutions and they started chasing debt-laden Indian real estate and infrastructure companies with poor growth prospects. When the 2008 crash hit the world, no market was spared. The Indian market crashed in sync with developed ones, as the herd behaviour of panic and fear took over. What about the decoupling this time?

Human minds display two notable features after observing some new evidence or data. One, we are predisposed to quickly seeing a pattern in that data. Two, we jump to conclusions and extrapolate. Both can turn out to be misleading. Just because India has outperformed the US markets in a short recent period, it does not mean that this is based on fundamental reasons that are here to stay (pattern). Nor is it possible to predict that it can continue with the help of just two months of data quickly extrapolated.
 

What about decoupling in dollar terms?

Well first, there is really no decoupling. Our idea of Indian outperformance comes from comparing the S&P500, which is a dollar-denominated index, to the Nifty or Sensex, which are rupee-denominated indices. It amounts to comparing apples and oranges. Also, the underperformance of the US indices and the outperformance of the Indian indices have no real practical meaning for Indian investors because we are not investing in the US anyway. It is relevant only to those foreign institutional investors who can invest both in the US and India. Over any medium to long period, they would have been better served by investing in the US than in India. As measured by indices, what they gained in capital appreciation, they lost in rupee depreciation. In dollar terms, the Indian market has always been a terrible performer. So, there is no real decoupling there.

Secondly, there are specific reasons for the recent outperformance as explained by a Twitter handle @PauloMacro: India suddenly seemed to be most attractive emerging market (EM) story — compared to Latin America, China, and Russia. A few months ago, Paul wrote foreigners realised “you can’t invest in China because who knows what comes next with Xi. Russia is out. Pink socialist tide is rolling in on LatAm (and how much of Mexico can you really own?) South Africa is a basket case. You have one option. The only deep, liquid EM to hold a ballast exposure in is… INDIA. And the best part, it’s a net importer of energy and oil is down now, so it feels safe now. Every EM (emerging market) manager I know… EVERY. SINGLE. ONE… is overweight India right now. Because there is nowhere else to go. There is literally nowhere else for size EM money to park.” This is the main reason why the Indian markets hit a 52-week high in August even as the US markets dropped to 52-week lows.

Now, these are very specific sets of conditions, of relative attractiveness, that got foreign investors suddenly interested in India for two months. Any post-facto justification of this move with big-picture “stories” like India’s infrastructure development, large market, China + etc. is a blend of patriotic and wishful thinking. The reason for India’s relative attractiveness will be forgotten overnight if the global market becomes even more stormy. As the rupee blasts through 81, the Indian central bank has blown up $90 billion in trying and failing to defend it. Following an extremely hawkish stance by the US Federal Reserve last week and large hikes by all global central banks, markets have entered a new period of turmoil. India’s weakness is an inherently weak economy with a current account and fiscal deficit and a weak rupee. The newly acquired strength is high-quality companies and domestic institutional and retail investments flowing into the markets. Markets will be driven by these two factors. Decoupling has no meaning in this equation.

The writer is the editor of www.moneylife.in

Twitter: @Moneylifers