Most are tempted to dismiss the stock market and its signals as something that doesn't affect the real economy. They're mistaken. Apart from the signals the stock markets give would-be investors on how the future is going to look, and the impact it has on companies' ability to raise funds to finance expansion plans, the sensex turns out to be a pretty good barometer of what's happening in the real economy as well. Goldman Sachs has an India Surprise Index (31 per cent of the index is made up by the industrial production index, 26 per cent by GDP figures, 23 per cent by exports and 20 per cent comprises motor vehicle sales). As it turns out, the India Surprise Index is quite well-correlated with changes in the sensex, overnight swap rates and the rupee/dollar rates. Earlier studies, notably by Susan Thomas of the IGIDR in Mumbai, have shown that equity values tend to be a very good indicator of whether a firm is going bust "� Thomas' work, of course, draws upon the KMV model that ratings firm Moody's now owns. So, while keeping tabs on the real economy is all very well, it may be a good idea to keep an eye on the sensex as well.
