By Nidhi Chaudhary

How do you gauge the mood of stock market in India? How do you decide whether things are hunky dory or depressing in the stock market? How do you take a call to make entry into the market or exit out of it? Though the answers to all these questions are not very easy, one very obvious parameter which gives a good understanding with respect to these questions is to look at “SENSEX” and “NIFTY” and its movements. SENSEX and NIFTY commands the same position in the stock market which “XEROX” has in the photocopy business and “BISLERI” has for mineral water, but do they indeed reflect the mood of the stock market and is it indeed a barometer of the Indian Economy?

Companies usually issue shares to fulfil their financial needs, it is the easy way of capital formation for the companies. Rise in price of shares depends on the profits of the company, if the company is in profits then the stock market value increases, which in turn increases the flow of investment in the stock market. This leads to capital formation and increased production capacity. As organisation have good capital and profits they expand. This expansion leads to creation of employment opportunities and improved standard of living. Shareholders’ wealth gets maximised as they get handsome share in the profits of the company. The dividends lead to the increase in the per capita income which in turn increases the GDP.

However, as the results season for 2014-15 draws to a close, it is closer that listed companies, particularly those making up the SENSEX and NIFTY, are lagging behind the broader economy this time around. The SENSEX constituents have closed with a 2.3 percent growth in sales and a 2 percent fall in aggregate profits. This is in contrast to government data which shows that India’s GDP grew at 11.5 percent this fiscal quarter. Sales growth for the SENSEX companies for the last three quarters hasn’t exceeded 5 percent, while GDP growth has averaged 9.8 percent.

Stock exchanges do not capture the mood of change in economy correctly. If we look at the way stocks have been included or excluded from the stock exchanges, we get the idea, inclusions and exclusions are not always based on logic. How can one explain that companies like “SUN PHARMA” which was included in SENSEX on 12th January, 2009 was excluded on 3rd May,2010 and was again included on 8th August,2011. Inclusions and exclusions should not be frequent especially considering that these indexes are often projected as the barometer of the Indian Economy.

Also, the sellers in the market basically reflect their opinions on future of the company’s share that they are holding. So, they act on what is known as “market sentiments”. These market sentiments are nothing but the feeling buyers and sellers have about the prices going up or down.

These sentiments are created from various news that can affect the performance of the company whose shares are bought or sold, which are:

1. Company News includes the internal factors that affect the company’s  performance such as Company’s annual reports, legal proceedings, signing of a new deal, Merger and Acquisition.
2. Industry News includes the development of the industry of which a company is a part of. Like the government announcing that it will raise the FDI limit in retail sector.
3. Economy News includes developments related to the economy wherein announcements like Inflation, Fiscal deficit etc. affect the share prices. For example:- if RBI increases interest rates because of rising inflation. As a result, borrowing cost of companies increases which adds to the cost of production and brings down the profits. This will bring down share prices of the most of the companies in the market.

As the globalisation of India’s largest companies is likely to be a continuing process, we may have to adjust to the fact that SENSEX or NIFTY can no longer be taken as the barometer of the Indian economy. After all the SENSEX captures the prospects of precisely 30 companies while the Nifty captures 50 while the Indian economy is said to feature 48 million SME.

One couldn’t have escaped some of these statements in the recent past: ‘The market has tanked, GDP figures were disappointing’, ‘another few hundred points down’, ‘the rupee is going to sink more’ or ‘inflation figures are going to be bad’. Sure, the disappointment in the tone and falling economic indicators have caught the attention of investors, but what most have missed is that the market is increasingly getting influenced by economic indicators and events-that which occur in faraway lands.

Headline Barometer such as SENSEX and NIFTY measure the broad market by tracking the price performance of a diverse portfolio of companies. However, sector level barometers can be indicative of trends for both the economy and consumer behaviour. For example:-increasing sales by companies in the consumer cyclical sector which includes electronic, travel etc.

Barometers that measure consumer behaviour include housing sales, consumer spending and durable goods sales. These barometers can be followed closely because consumer spending represents approximately 70% of the nation’s GDP and the earliest signals of the shift in the economic landscape are often indicated first by changes in consumer behaviour. Many of the barometers that measure economic trends are issued by government agencies and departments. For example:-the monthly unemployment rate and inflation rate.

The answer to this question is: While SENSEX is a good indicator of the performance of the economy it can never be or, at least should never be taken as the barometer of the Indian economy. Movement in share prices can always indicate economic health, but never measure it. Measurement of health of the economy should always be left to the key-economic indicators and not share price movements that reflect sentiments. If you are studying the health of the economy as a student/analyst, then again taking SENSEX as a measure will be ill-advised, taking it as indicator will be preferable.

So, never quote SENSEX as the barometer of the economic health but as an indicator!

Image Source- Business Today

Nidhi Choudhary is a bachelor’s student at Jindal School of International Affairs