The correlation between the US and Indian markets: It's mostly sentiment

When India was a developing country, there used to be a joke about US – Indian relationship. It was that “when the US sneezed, it was India that caught a cold.” While this may or may not be true geopolitically, at least the linkages between US economy and bourses and the Indian markets are gradually reducing.

And while, there will never be any total break in linkages between the US economy and Indian bourses, experts inform us how to navigate these foreign shoals. Even the dreaded US interest rate hikes.

“In last few years (5-10 years), the dependency (correlation) of Indian market relative to US market has reduced significantly,” says Amar Ranu, Sr. VP & Head - Investment Products and Insights, Anand Rathi Shares and Stock Brokers.

Till a decade back, the correlation between the US and Indian equity market used to be 0.6 to 0.7 which reduced further to 0.4-0.5 currently. The reasons are multiple – the domestic nature of the Indian economy, strong domestic inflows and less sensitivity to global market cycles.

Even now when there is talk of recession in US market (as yield curve inverted), in India, there is no sign of anything near that and the market has been thriving on all fronts.

“There may have been phases when the Indian markets, mirrored US markets quite closely, but today there is limited co-relation overall,” Girish Lathkar, Co-Founder and Partner, Upwisery Private Wealth.

On a more technical level, Rahul Bhutoria, Director and Founder, Valtrust, feels that there is some level of correlation between the movements of the Sensex and Nasdaq, but it's not considered a strong relationship.

On the other hand, if the difference between the Dow Jones and Sensex is low correlated, it implies that the two indices' movements have less tendency to move together, as a general guide to those who may wish to identify movement linkages between US bourses and their Indian counterparts.

So is there no linkage between US equities and Indian equities. Yes there is – somewhat! It's mostly sentiment.

“The US is the mother market which leads other markets up or drags them down,” says Dr. V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services. Last year most markets delivered negative returns on global growth slowdown fears. The US, Euro Zone and most emerging markets were down.

There will be minor variations. For instance, last year while most markets delivered negative returns Nifty delivered 4 percent positive returns. However, such small out performances will not be major deviations from the global trend.

So what are the actions that we can expect from the US and how will they affect Indian bourses?

“There is general tendency when yields go up in USA because of rate hikes, there is flight-to-liquidity i.e. US investors are better off investing into their bonds at higher yield and their risk propensity to emerging market or India reduces,” says Ranu.

Generally speaking, when there is an interest rate hike, it impacts the equity market as it becomes more expensive for businesses and consumers to borrow money, which can slow down economic growth and thus, can cause a decrease in corporate profits.

The relationship between interest rates and equity market is complex and not always straight forward and there are many factors like GDP growth, unemployment rate, and inflation which impact the same.

Even in the US, where the Fed has been increasing the policy rates, the equity market is still in positive territory because of strong employment rate which is leading to growth consumer demand and propensity to spend.

In line with expectations, earlier in July, the US Fed raised its policy rates by 25bps (basis points – one basis point is one-hundredth of a percentage point) to 5.25%-5.50%, a 22 year high. The Fed Chair left room open for further rate hikes and reiterated that the decision will be contingent on incoming data. However, rate cuts in CY23 were ruled out. High inflation, particularly on the services side, as well as tight labour market remain key risks for the Fed, according to a research note from Bank of Baroda.

Interestingly, on that particular day most global indices, including the US, traded in a flat range. The Dow Jones, in fact gained by 0.2 percent.

Incidentally, experts give a ballpark idea of how US markets may fare in the near-term, just so we know.

The movement of the US equity markets will be primarily driven by US inflation and the strength of the economy. If the US disinflation trend continues and inflation comes under control as the Fed wants, then the Fed will end this rate hiking cycle with just one more rate hike. This will be a positive message for the stock market.

More importantly, if the US economy continues with its current strength and avoids a recession, the market will continue to move higher.

On the other hand, if the US economy tips into recession by Q4 or shows signs of tipping into recession in early 2024, the US market will go down and this will impact all other markets, says Vijayakumar.

So, experts guided us through the sectors that are (relatively) linkage proof to tremors in the US Economy – hardly surprisingly those which have an exposure to the US exports would be buffeted and those with an India focus would not.

“IT is the sector which has the maximum direct impact, both on the upside and downside. Pharmaceuticals is another sector which has strong linkages to the US economy. Both these are export oriented sectors and the US is the largest market,” says V K Vijayakumar.

Contrarily, the sectors which are least affected are the domestic consumption facing sectors such as financials, automobiles, real estate and construction, capital goods and FMCG.

“As a general thumb rule, investors can look at investing 5%-10% of overall equity allocation in US equities, depending on one’s risk appetite and ability to track US markets,” advises Lathkar. Investments in offshore equities should price in the currency fluctuation and awareness of taxation – both LRS (liberalised remittances scheme) and at the time of redemption.

Manik Kumar Malakar is a personal finance writer.