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Global 'Cues'

The Indian markets rise and fall with the US (perhaps global is more politically correct) markets but they rise a lot more when they are rising and fall a lot more when they are falling

On Friday, the Indian stock markets dropped sharply, with both the Sensex and the Nifty dropping by around 3.5 per cent. However, there was complete consensus on various websites, business channels and newspapers about the cause of this drop. The stock market had 'taken a cue' from the global markets, to use a phrase that was probably the most used of the day. The US markets had fallen sharply on Thursday and thus on Friday, as Asian markets opened one by one, they all took their cues in an orderly fashion from one another and were flat on their backs by the end of the day.

Now, I am not arguing against this story-it's pretty clear that this is pretty much what actually happened on Friday-but I think the history and geography of this cue-taking bears a little examining. At least that's what I decided to do after having had my fill of newspaper articles about global volatility sweeping into Indian markets on Saturday. While it's easy to talk about the impact of the global markets on Indian ones, what is exactly is the nature of this impact?

How come we hear about it only on some days? One gets the impression that there are days when the influence of global markets is mentioned a lot and other days when it is ignored.

To figure out this connection I took up the daily history of the S&P 500 index of the US markets and the Nifty since 2004 and did some number crunching on them. The results were interesting, to say the least. At a broad level, the two indices have a very high degree of correlation. While one can brandish all kinds of heavy-weight statistical tools to prove this point, the best proof is just eye-balling a graph of the two indices. It's immediately clear that for this period, Nifty's graph is an 'exaggerated' version of the S&P 500's graph. It's as if someone has drawn the US market's graph on a sheet of rubber and then stretched it out vertically. The Indian markets rise and fall with the US (perhaps global is more politically correct) markets but they rise a lot more when they are rising and fall a lot more when they are falling.

So does that mean that this global cue business really works and each day's movements are basically derived from the previous day's 'global' moves. Well, the data we've looked at doesn't actually say that. To see how strong is the day-to-day correlation, let us look at each day and see whether the previous day's movement on the US markets influenced the Indian stock markets. This is admittedly a somewhat simplistic measure but would probably give us some idea of whether the longer term influence has any day-to-day predictive value. The answer, is a bit of a letdown. Of the 750-odd days in my sample, the Indian markets took the cue from the US markets on about 385 days (51 per cent). This is exactly what you would expect between any two set of random numbers. I hate to disappoint everyone who's looking for some hidden variables here but that's all there is to it. As sages from Warren Buffett downwards have observed, no matter what the long-term trends are, the day to day movement of stocks and their indices are more or less random. This applies to correlation between different markets also. So what about those global cues one hears about so often?

Here's my explanation. There are a large set of people, who, out of behavioural compulsions or professional duties, need to find explanations for the markets' movements every single day. It's a tough job, and they need all the help they can find. On days that the global markets and Indian markets have moved in the same direction, the cues come in handy. On other days, the job's a bit harder.