Sentiment and Sensex: A surprisingly divergent trend

Consumer sentiment down nearly 11% cumulatively in the first fortnight of 2017

The BSE-CMIE-UMich Consumer Sentiment Index declined by 3.9 per cent during the week ended January 15. This was on top of a 7.3 per cent fall that the sentiment suffered in the preceding week. The cumulative fall in consumer sentiment during the first fortnight of 2017 was thus nearly 11 per cent. This is a substantial fall for a 15-day period. In fact, it is the steepest fall for any fortnight since the index was launched last January.
 
Sentiment seems to be falling down at a steeper gradient than its initial ascent since demonetisation.
 
What is striking about last fortnight's fall in consumer sentiment is its stark contrast with the trajectory of the BSE Sensex. While sentiment declined 11 per cent, the BSE Sensex increased 2.3 per cent. This contrary trend in the two indices is surprising. The opposite direction of equity markets and sentiment is more pronounced if we consider broader indices like Nifty or COSPI. While the Sensex rose 2.3 per cent, the Nifty rose 2.6 per cent and the market-wide COSPI rose 4.0 per cent.
 
The correlation between the equity markets and consumer sentiment is weak, but it is positive. The correlation between the two sets of weekly values (weekly returns on the Sensex and the weekly change in consumer sentiment) was 0.155 in 2016. The correlation between the two strengthened after demonetisation. In the first eight weeks after demonetisation, the correlation was 0.460.
 
Given this history of positive correlation between returns on the BSE Sensex and consumer sentiment, the contrary trend for the two during the first fortnight of 2017 is surprising.
 
The Sensex reflects the views of equity share owners. In fact, to a large extent, it is the view of foreign portfolio investors, public sector institutions and private mutual funds. It may be fair to say that the Sensex and Nifty reflect the views of fund managers of large institutional investors. Sure, retail investors are there is a large number, but it is the large weight of institutional investors that determines the direction of equity indices.
 
The sentiment index, on the other hand, is based on a large representative sample of India’s population. And, apparently, there is disconnect between what large institutional investors tell about India and what households in India seem to be telling us. The disconnect gains a little larger dimension with the following data: During last fortnight, the consumer sentiment index dropped in both rural and urban areas, but it dropped a lot more sharply in rural areas (-12.9 per cent) compared to urban areas (-7.9 per cent).
 
Evidently, while the institutional equity owners are quite sanguine about the markets and, by extension, the economy, urbanites are quite pessimistic. And, the rural folk are a lot more pessimistic than even the urbanites.
 
Institutional investors in equity markets have more information than households, and urban households have more information than rural ones. Markets discount a lot more information to price reasonably liquid assets efficiently. But, the received wisdom is that sentiment matters a lot more than fundamentals for prospects of the markets and, by extension, the economy.
 
For example, Roger M Edelen (University of California), Alan J Marcus and Hassan Tehranian (both, Boston College) find (Relative Sentiment and Stock Returns, in Financial Analysts Journal) that retail sentiment is a primary driver of equity valuations for reasons unrelated to fundamentals. Their study spans 50 years ended 2008.
 
So, could the sharp fall in sentiment indicate a corresponding correction in equity markets in the coming weeks? Further, does the fall in sentiment also indicate a deteriorating economic scenario in the near to medium term?
 
More or less, everyone has a sentiment and collectively this sentiment does play a role in the course the economy takes. People's decision to buy consumer durables is not influenced by income and wealth alone. These decisions to buy or not to buy collectively signal turns in the economy for the better or for the worse. The near about-turn in the sentiment index since mid-December, therefore, is loaded with a message that the economy could suffer a serious downturn. How can the equity markets be isolated from this message and the possible downturn?
 
If rural households vote strongly negatively on sentiment in spite of a better rabi crop, the message for the economy is loud and clear.

ANOTHER SHARP DECLINE IN SENTIMENT



Sentiment gauge



UNEMPLOYMENT ALSO RISES



Unemployment gauge



Every Tuesday, Business Standard brings you CMIE’s Consumer Sentiments Index and Unemployment Rate, the only weekly estimates of such data. The sample size is bigger than that surveyed by the National Sample Survey Organisation. To read earlier reports on the weekly numbers, click on the dates:
November 21, November 28, December 4, December 11, December 18, December 25, January 1, January 8  Methodology

Consumer sentiment indices and unemployment rate are generated from CMIE's Consumer Pyramids survey machinery. The weekly estimates are based on a sample size of about 6,500 households and about 17,000 individuals who are more than 14 years of age. The sample changes every week but repeats after 16 weeks with a scheduled replenishment and enhancement every year. The overall sample size run over a wave of 16 weeks is 158,624 households. The sample design is of multi-stratrification to select primary sampling units and simple random selection of the ultimate sampling units, which are the households.

The Consumer Sentiment index is based on responses to five questions on the lines of the Surveys of Consumers conducted by University of Michigan in the US. The five questions seek a household's views on its well-being compared to a year earlier, its expectation of its well-being a year later, its view regarding the economic conditions in the coming one year, its view regarding the general trend of the economy over the next five years, and finally its view whether this is a good time to buy consumer durables.

The unemployment rate is computed on a current daily basis. A person is considered unemployed if she states that she is unemployed, is willing to work and is actively looking for a job. Labour force is the sum of all unemployed and employed persons above the age of 14 years. The unemployment rate is the ratio of the unemployed to the total labour force.

All estimations are made using Thomas Lumley's R package, survey. For full details on methodology, please visit CMIE India Unemployment data and CMIE India Consumer Sentiment.

The creation of these indices and their public dissemination is supported by BSE. University of Michigan is a partner in the creation of the consumer sentiment indices.