Sensitive indexes

| Updated on March 12, 2018 Published on August 12, 2013

The Nifty and Sensex have ceased to reflect the ‘true’ performance of Indian stock markets today.

A stock market index is expected to provide a measure of the value of a group of stocks. But the two benchmark stock indices, the Sensex and Nifty, have been shown up as hopelessly inadequate in doing this. Even as the majority of stocks are in deep declines or languishing near their bear market lows, the two indices are still putting up a façade of relative resilience. Until almost the end of last month, they were ruling hardly 4 per cent below their life-time peaks of January 2008. The difference has since widened to 11-12 per cent, but even this hardly reflects the battering that most stocks have taken. Some 45 per cent of the stocks traded on the National Stock Exchange are now quoting below their October 2008 lows.

This anomaly underlines the need for the country’s exchanges to undertake a review of the methodology for computing their benchmark indices. After all, just as one expects the official Index of Industrial Production or the Wholesale Price Index to reasonably capture output or inflation trends in the economy, the Nifty or Sensex ought to be barometers of the ‘true’ state of affairs in Indian markets. Currently, both benchmarks are calculated by multiplying the ruling market price of stocks constituting the two indices with their ‘free float’ – that is, the total shares available for trading after excluding the holdings of promoters. This method automatically lends itself to a few stocks with higher free float or a few others that experience a sharp run-up in their prices dominating the overall index movement. It is precisely these kinds of movements, for instance, in pharma or consumer goods stocks that have camouflaged the heavy losses of their peers in the infrastructure, power or commodities space.

One way to address the issue is to cap the weights assigned to each stock, so that a few shares do not skew the index performance. The modified market capitalisation-weighted method employed in the Nasdaq-100 index, which caps the influence of large stock components, could act as a guide here. The Nifty and Sensex also suffer from not having agri-commodity related stocks or adequate representation from sectors such as real estate and construction.  Thus, they do not provide a useful gauge of activity in the Indian economy. The exchanges also need comprehensive indices to capture movements of at least all traded stocks. Something on the lines of the broad-based Wiltshire-5000 Total Market Index in the US could well serve as a model. True, with increasing concentration resulting in the top 100 stocks accounting for over 80 per cent of the daily turnover in Indian exchanges, there may be many stocks whose performance are of little interest to investors. But that doesn’t still justify overlooking their price movements while assessing the performance of the traded stock universe.

Published on August 12, 2013
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