Indian stocks decouple from global bull-run

The word ‘decoupling’ is being heard quite frequently over the last month and it is not difficult to understand why.

The market benchmark, Sensex, is down around 8 per cent since its February peak but markets in most other countries are in fine fettle, hitting new highs in this period. The US bellwether S&P 500 has rallied 5 per cent, Germany’s DAX index is up 7 per cent and France’s CAC index is up 6.5 per cent since February.

There was a global rout in February triggered by the sharp spike in yields of US treasury securities on fears that the second wave of the virus and rising inflation could derail growth. But concerns of the advanced economies appear to have been assuaged to a large extent by the $1.9 trillion stimulus bankrolled by the Biden administration in March. The prospects of continued liquidity has been enough for equities in these countries to continue trading at elevated levels.

But there has been a stark change in the movement of the Indian equity market since March. It did not participate in the rebound in global equity markets since then and has even underperformed some of its emerging market peers over the past month.

The reason behind this under-performance is the ongoing second Covid-19 wave. India is currently reporting the largest number of new cases globally. With daily cases moving past 2,50,000, the healthcare infrastructure is gasping to cater to the rising case load, and States are resorting to limited lockdowns, impairing economic activity in the process. The vaccination programme is also stuttering, as of now.

This crisis comes at a bad time since foreign investors are closely monitoring the progress of the pandemic in each country to decide on their allocations. FPI flows have already turned negative and this is also responsible for Indian equities’ relative under-performance.

The ongoing correction can however be stemmed if the Centre and the States act fast to contain the surge in cases.

India decouples from others

One way to establish the linkage between Indian equities and other markets is through correlation analysis. Our analysis of correlation between MSCI India and other regions, in recent months, threw up some interesting results.

For the period between February 15 and April 20, the correlation between MSCI India and MSCI US indices turned negative at -0.11, indicating that the two markets moved in opposite directions in this period.

Similarly, MSCI India’s correlation with MSCI EU also turned negative at -0.21. The US and the countries in the EU bringing infections and death rate under control, coupled with brisk pace of vaccination, has resulted in gains for these markets over the last couple of months.

While MSCI India’s correlation with MSCI EM and MSCI Asia was positive since February 15, indicating that the markets moved in the same direction, the correlation has weakened significantly when compared with 2020, when India’s correlation with these regions was above 0.90 (see table).

The weakness in Indian markets has been led by foreign portfolio investors turning averse to Indian equities. After net purchases of ₹2,74,032 crore in FY21, FPIs have pulled out ₹7,042 crore of stocks in April 2021.

A look at the FPI flows into other emerging markets shows that FPIs have continued to be net buyers in markets such as South Korea, Taiwan and China, while pulling money out of others.

How FPIs are allocating

The differentiation in country allocation by FPIs seems to be linked with how swiftly governments have acted to contain the Covid-19 virus.

The reason why China, South Korea and Taiwan are being favoured is largely due to their response to the pandemic.

“Countries that imposed stringent lockdowns, tested and tracked their citizens and thoughtfully reopened their economies with caution have rebounded sooner than the rest. In this context, China, Taiwan and Korea have proven to be world-beaters; we think their economies may regain normal levels of activity as soon as the second quarter,” writes Goldman Sachs Asset Management in its report.

Lazard Asset Management writes that for most emerging markets, vaccination against Covid-19 remains a story for the second half of this year and into 2022.

“Lack of adequate vaccine supply in emerging markets, the large purchases of vaccine doses by developed markets, and a late start to vaccinations in Asia explain much of the gap between emerging and developed countries.”

If the year-to-date returns of primary stock indices is considered, Taiwan’s stocks have delivered 17 per cent return and South Korean stocks have gained 12 per cent. Russian stocks have also gained 8 per cent due to containment of the pandemic over the last two months.

Damage can be contained

Global investors were initially betting that the vaccine rollout in India and the containment of the virus until February will sustain, leading to strong growth in the second half of 2021.

FPI inflows therefore remained strong until March.

But the ongoing crisis in healthcare facilities, vaccine shortage and surging cases have clearly made the global sentiment towards India equity negative.

Brokerages, including Nomura, JP Morgan, Citi and UBS, revising the growth for 2021-22 lower has not helped matters.

Given that the valuation of Indian markets, with Sensex trailing price earning ratio at 33 times, is much more expensive compared to other emerging economies, the setback in the form of impact on consumption and growth, even if it is short-lived, will rein in the rally that began last April.

The tailwinds from higher commodity prices, low-base effect helping earnings growth and revival in government capex will be negated by the second wave, at least in the near term.

The extent of the decline will however hinge on how fast the Centre and the States get their act together in testing, isolating and vaccinating the population. Once the daily cases and fatalities begin reducing, equity prices could also stabilise. The authorities need to keep in mind that their actions will be the key drivers for the market over the next few months.

COMMENT NOW