Indian Markets: Decoupling Theory Gains Currency again
Buffeted by bad news since late last year, global markets have been falling more or less in sync right until mid-June this year. Around 17th June, markets around the world made a short-term bottom and rallied fast, right until mid-August. 
 
During these two months, the NIFTY rose from 15,319 on 17th June to 17,980 on 18th August - a rise of 17.7%. At the same time, S&P500, the leading US index, went up 17.7%. There was no surprise here. Global markets usually move up and down in sync, in response to global macro news. 
 
But what happened next was truly stunning and against all conventional assumptions. From 4,305 on 16th August, the S&P500 slumped 14.2% to 3,693 by 23rd September, wiping out almost all the gain of the previous two months. 
 
Strikingly, however, the NIFTY has dropped from its peak of 17,980 of 18th August by only about 3.6%, over the same period. NIFTY has just performed a stunning feat of a 10.6% outperformance, that has turned an old maxim on its head: “When the US market sneezes, emerging markets catch a cold.” 
 
India’s sharp and surprising outperformance has led to a chorus of predictions that India and the developed markets are getting decoupled. In a climate of bubbling patriotism, such ideas catch on fast. We last heard of decoupling in the big boom of 2003-2007, when the Indian market rose more sharply than the US market. 
 
However, once this became evident, it soon became the popular view among foreign institutions and they started chasing debt-laden Indian real estate and infrastructure companies with poor growth prospects. When the 2008 crash hit the world, no market was spared. Indian markets crashed in sync with developed ones, as herd behaviour of panic and fear took over. What about the decoupling this time?
 
Human minds display two notable features after observing some new evidence or data. One, we are predisposed to quickly see a pattern in that data. Two, we jump to conclusions and extrapolate. Both can turn out to be misleading. Just because India has outperformed the US markets in a short recent period does not mean that this is based on fundamental reasons that are here to stay (pattern). Nor is it possible to predict that it can continue with the help of just two months of data quickly extrapolated.
 
What about Decoupling in Dollar Terms?
 
Well, firstly, there is really no decoupling. Our idea of Indian outperformance comes from comparing S&P500, which is a dollar-denominated index, with the NIFTY or the Sensex which are rupee-denominated indices. It amounts to comparing apples and oranges. 
 
Also, the underperformance of US indices and outperformance of Indian indices has no real practical meaning for Indian investors because we are not investing in the US anyway. It is relevant only to those foreign institutional investors who can invest both in the US and India. 
 
Over any medium to long period, they would have been better served by investing in the US than in India. As measured by indices, what they gained in capital appreciation, they lost in rupee depreciation. In dollar terms, the Indian market has always been a terrible performer. So, there is no real decoupling there. 
 
Secondly, there are specific reasons for the recent outperformance as explained by a Twitter handle @PauloMacro: India suddenly seemed to be the most attractive emerging market (EM) story compared to Latin America, China and Russia. A few months ago, Paul writes, foreigners realised, “You can’t invest in China because who knows what comes next with Xi. Russia is out. Pink socialist tide is rolling in on LatAm (and how much of Mexico can you really own?) South Africa is a basket case. You have one option. The only deep, liquid EM to hold a ballast exposure in is… INDIA. And the best part, it’s a net importer of energy and oil is down now, so it feels safe now. Every EM (emerging market) manager I know… EVERY. SINGLE. ONE… is overweight India right now. Because there is nowhere else to go. There is literally nowhere else for size EM money to park.” 
 
This is the main reason why the Indian markets hit a 52-week high in August even as the US markets dropped to 52-week lows. 
 
Now, these are a very specific set of conditions, of relative attractiveness, that got foreign investors suddenly interested in India for two months. Any post-facto justification of this move with big picture 'stories' like India’s infrastructure development, large market, China+1, etc, is a blend of patriotic and wishful thinking. 
 
The reason for India’s relative attractiveness will be forgotten overnight if the global market becomes even more stormy. As the rupee blasts through 81 to the US dollar, the Indian central bank has blown up US$90bn (billion) in trying and failing to defend it. 
 
Following an extremely hawkish stance by the US Federal Reserve last week and large hikes by all global central banks, markets have entered a new period of turmoil. India’s weakness is an inherently weak economy with current account and fiscal deficit and a weak rupee. 
 
The newly acquired strength is high-quality companies and domestic institutional and retail investments flowing into the markets. Markets will be driven by these two factors. Decoupling has no meaning in this equation.
 
(This article first appeared in Business Standard newspaper)
 
Comments
pmbhate
2 months ago
Tracking of USD 100 invested in the Dow Jones Industrial Average (DJIA) and an equivalent INR amount in the Sensex every quarter since 1980 shows that when markets closed on 4 October 2022 the accumulated Indian holdings were 19% higher than accumulated US holdings. Can’t call this a terrible performance. True, the Indian assets at some point were only a third of the US assets; equally true that at a different point, these were also twice the US assets. Only decoupling is seen here.

If 43 years is too long, let’s look at the same numbers since 1985. The ratio of accumulated Indian assets to US assets touched a high of ~2.3 and a low of .34; at market close on 4 October Indian assets were 25% higher. Again, decoupling and a very good performance by the Indian market.

The numbers change with different years as the starting point of the investment journey:

1990: high of ~2.5, low of ~0.4 and 33% higher on 4 October
1995: 3.33, 0.5 and 54% higher
2000: 3,83, 0.82 and 51% higher

Things change a bit after this:

2005: 2, 0.7 and 2% lower
2010: 1.1, ~0.7 and 5% lower
2015: Will talk about this only in early 2026. Anything less than ten years is a no-no for me.

I am OK with sharing all these Excel sheets with interested readers.

By no stretch of imagination can one call the Indian market a terrible performer – despite continuing depreciation of INR, despite SEBI, despite NSE and the Himalayan Yogi, despite demonetization, despite RBI, despite scams, despite all the inefficiencies.

There is something in the Indian market that makes it tick!
Kamal Garg
Replied to pmbhate comment 2 months ago
Correct. The decoupling theory is a humbug.
"Despite Himalayan Yogi" - loved this one.
Ezhilarasan M
2 months ago
well put
Amit Dubey
2 months ago
But The volatility in currency market , is incentivising Emerging market & world to ditch dollars.....

If $remains strong for too long there ll be no option left
Kamal Garg
2 months ago
I think every time when there is a divergence in US and Indian indices, the theory of decoupling gains ground. Whereas on a longer term, there is no decoupling. The recent exuberance in Indian markets was because of regained inflow by FII which has now almost dried up because of consistent increase in interest in US along with geopolitical crisis and fear of recession in all major economies of the world including US, EU, etc.
Prithwiraj Chaudhuri
2 months ago
thank you another great read , as a new investor learned a lot of things from this articles ... hope with falling oil and commodity prices inflation comes under control ... sir ur twitter feed also very informative thank you
ketan.chheda
2 months ago
We should compare S&P500 with Nifty500 or BSE500...not BSE SENSEX or Nifty50...No?
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