Singing Different Tunes

Parag

Shah, a veteran trader of the past 35 years, has made his money keeping his ears

close to the market. During the Harshad Metha-led crash of 1992, he lost about

Rs8 lakh, because he got the information late–by the time he got it, the

stampede had already begun. However, he is more relaxed nowadays as he has

information about the next day’s market trends about 10-12 hours in advance.

Bless the Nasdaq, he says.

‘Nasdaq sneezes and Sensex

catches the cold’ has become a common refrain in the stock market. And not

without reason. Consider these statistics. The Bombay Stock Exchange’s

sensitive index, Sensex, fell by about 361 points on April 4, the dark Tuesday.

The Nasdaq Composite, the equivalent on the Nasdaq of the Sensex, closed the

previous trading day, April 3, dropping 349 points from its day’s open. The

Sensex again had a free fall on April 17 when it lost 291 points. The previous

Friday, April 14, the Nasdaq was battered, registering its biggest fall in

recent times–of about 355.51 points. The trend in the market was evident. On

the morning of April 17, leading financial newspapers screamed warnings of an

imminent black Monday in the Indian market, and sure enough the Sensex ended the

day dropping 5.61%.

Is the Indian market playing to

the Nasdaq tune? Is the infamous ‘foreign hand’ becoming a sour point for

investors on the Indian market? These are questions people are trying to solve

to get a better perspective of the market.

Watching for links

It is imperative

to understand the rationale of stock market movement before trying to analyze

the correlation. According to market analysts, ‘it is sentiments in the short

run and fundamentals in the long run’. A good example of the short run

sentiments would be the fall of 361 points on April 4. Though the market was

concerned by a few worries like taxation on foreign institutional investors (FII),

these were not concerns that would have pulled the Sensex down by its second

biggest drop since the Harshad Mehta days.

However, since sentiments were

already low with the Nasdaq close, the market reacted violently. Agrees Suhas

Naik, Analyst, Infrastructure Leasing and Finance Services, "Nasdaq was

only one of the contributors that led to the crash. The other thing was the

taxation on FIIs. That became a major issue and with fear setting in, there was

no inflow of money."

Nothing had happened over the day

to warrant such a huge fall. But then such are the ways of the market.

The market is all about

perception. One analyst would be upbeat about a stock and would recommend a ‘buy’

while another would be pessimistic about the same stock. This can happen despite

the fact that the analysis is governed by the same underlying factors. The same

is true across the globe, else why should comments on the unsustainability of

dotcom companies from Mark Mobius, President, Templeton Emerging Markets and

Abbey Cohen, Chief Investment Strategist, Goldman Sachs, lead to a carnage on

Nasdaq?

Once there is a sell off, panic

sets in fast and the downward or upward cascade begins. The same has been

happening on the Indian markets for quite some time. Until a few months ago,

factors governing market dynamics have been India-specific issues like

government policies, the budget and other local issues. However in recent times,

it has been Nasdaq that has been calling the shots. Or has it? Naik says,

"There is no direct one-to-one correlation between the volatility of stocks

on the Nasdaq and the Indian markets as it is made out to be." R Ravi, VP,

I-Sec, holds a similar view. He says, "There is no direct co-relation

between Indian bourses and Nasdaq. Yet market operators use Nasdaq as the

benchmark for guessing the mood and sentiment of the market.Figures say it all

A comparison

between the Nasdaq Composite and Sensex figures would tell whether there really

exists any kind of correlation between the two. Whether Nasdaq should be used by

market participants as a benchmark? How right is it as a benchmark?

On a daily basis, from January

2000 onwards, we do find some kind of correlation. But if we see the daily

change on the Nasdaq and the Sensex, of



the total 77 days of trading activity, the Sensex has mirrored the Nasdaq about
55% of the days. No wonder, the big scary headlines in most of the financial

dailies point to the correlation. It has been the drops or the negative

sentiments, which have been hogging the headlines. All you hear are black

Mondays and dark Tuesdays but not bright Wednesdays or white Thursdays.

According to a top analyst with a

leading International Brokerage House, "There is some extent of correlation

between the two, but it is more sentiment driven. As and when the sentiment sets

in, it typically tends to take a correction."

This disparity grows wider as the

time frame is increased. For a weekly data analysis from August 1999 onwards,

both the indices were found to fall during the third week of April. The Nasdaq

saw its index erode by a whopping 1,124 points while the Sensex was down by just

47 points. The next big fall happened in the last week of March 2000 with the

Nasdaq falling 390 points and the Sensex losing only about 140 points.

The important questions are

whether one needs to actually correlate the fundamentals of Nasdaq-listed

companies to BSE-listed companies. Most of the new economy Indian stocks are

still in IT services with a concrete revenue and business model. However, in the

technology exchange as Nasdaq is usually considered, the hype has been largely

due to the dotcom companies–many yet to earn a penny of net profit. Comments

Ravi, "Indian IT companies are involved in IT services and revenue and

profit growth will continue to be robust. Standalone valuations of Indian IT

companies have been stretched, correction is welcome, but extra-polating to

Nasdaq is a bit illogical." Also can Nasdaq be called a technology exchange

considering that computer related stocks account for just a little over a tenth

of the total number of Nasdaq listings?Where the correlation could be

possible is a one to one correlation of the same stock listed on both the

exchanges. However, studies done by equity analysts prove that there is no

strong correlation. Says Mahesh Vaze, Analyst, Motilal Oswal, "There was a

study done on the correlation of Infosys on the Nasdaq and the domestic market

and the correlation coefficient was found to be 0.46. This is very low."

Agrees Ravi, "Any correction in Nasdaq of Indian listed IT companies will

automatically see some kind of weakness of the domestic stock price on the next

trading day and vice versa."

Is there a relation?

Though most

of the market players agree that it does not make sense to directly correlate

the two stock exchanges, yet one cannot stay away from such comparisons.

Unlike the older New York Stock Exchange, Nasdaq symbolizes the new age stock in

the knowledge economy or the infotech, media and communication (ICE) stocks.

These are ‘perceived’ as sunrise industries compared to the old age

manufacturing industries. The same perception is being replicated on the other

global exchanges like Hong Kong and Tokyo. India is no different. In the Indian

market the valuation of IT and ICE stocks represent nearly 40% of the market

capital of Sensex. So if Nasdaq falls, it is bound to set off a chain reaction

across the globe. Moreover, as Nasdaq keeps setting trends, any stock exchange

in the world will dance to the tunes of Nasdaq. Agrees Vetri Subramaniam, Chief

Advice Officer, Sharekhan.com, "In the short term we will take our cue from

the Nasdaq, which is the leading indicator for technology companies. It is

unavoidable."

So it is okay for people like

Parag Shah to look at the Nasdaq for daily trends but if you are looking for

medium or long term investments, it does not make sense to be unfazed by the

daily gyrations of the market. Look at the company’s fundamentals rather than

linking Nasdaq and Sensex to make the quick buck.

YOGRAJ

VARMA