Moneycontrol
Aug 05, 2017 10:08 PM IST | Source: Moneycontrol.com

The dollar index indicates looming trouble for Indian shares

The Dollar index, a measure of the value of the US dollar relative to a bunch of major global currencies, has generally shown an inverse correlation with the India equity indices – in other words, if it rises, Indian shares fall, and vice versa.

Sidhartha Shukla @shukla_05sid

Sidhartha Shukla

Moneycontrol

In the last one month, the Sensex has rallied around 1,600 points to 28,400 and is again inching towards its all-time high. The obvious question swirls: Will this momentum sustain, or will there be a fallback?

With the Union Budget out of the way, two key factors could determine the index’s fate: the rollout of GST and the adequacy and spread of this year’s monsoon.

There’s also a third indicator, which falls in the category of stock market correlations: The performance of the US Dollar index.

The Dollar index, a measure of the value of the US dollar relative to a bunch of major global currencies, has generally shown an inverse correlation with the India equity indices – in other words, if it rises, Indian shares fall, and vice versa.

In the past few months, USD index has seen a gradual uptick and has breached the 100 point mark. This could spell bad news for the domestic market.

The correlation can be explained fairly easily. A strong dollar may be good for the shares of Indian exporters but the wider effect is that it makes foreign institutional investors (FIIs)  move in a herd towards dollar assets and away from emerging markets.

From the chart above the following observations can be made:

*  In 1999, the USD index rallied and breached the 100 mark and sustained to stay above this point for the next three years; in the same time interval Sensex gradually fell or remained flat.

* In 2003, the dollar index dropped below the 100-point mark and continued to remain below this level till mid 2008; in this period Sensex rallied from 6000 to levels of 20,800 by the end of 2007. Post 2007, it started shedding gains and saw a steep decline, and at around that point, the USD index perked up.

* Global markets went into a tailspin in the aftermath of the 2008 financial crisis; from March 2009, the USD index declined until the end of the year, the same period in which the Sensex rallied.

*  The correlation weakened between May 2014 and March 2015, when the Narendra Modi-led NDA won the general elections and both the dollar index and Sensex saw an upward trend.

* As the dollar index found floor near the 100 mark in March 2015, the Sensex started to decline and fell to levels of 22,900 in February 2016.

Why is the dollar index gaining? The ascent of Donald Trump may have caused ripples geopolitically, but his outlined recipe for growth has done wonders for the greenback.

There islikely to be big infrastructure spending, corporate tax reforms and possible rate increases by the Fed. All this could drive FIIs to move away from emerging markets including India and make a beeline into US dollar assets.


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