ICICI Securities: The decoupling theory revisited

And so the phantom named 'decoupling' has been sighted all over again... Its date of birth is not too long ago. Along with globalisation and the globalisation of media, you and I have seen this phantom arrive.

When the US went asunder, first we watched in horror. Then we waited with baited breath and then we started breathing gradually. Soon we were breathing at our natural pace. Suddenly, whether or not we were decoupled, it certainly seemed that way.

Yet there is no denying that the day begins sometime in the night, as we watch the global markets waking up one by one, casting a certain flavour of expectation for the day that lies in waiting here in India. But that's on a daily basis. And then one day, the US employment data or some such valid surrogate makes its seasonal entry, threatening to shape our season as well.

Of course, interspersed within these global surrogate numbers are our own numbers - corporate earnings and results, the inflation, the GDP numbers, the IIP, the monsoons and the like. And depending on which window one is looking through, the view changes. From the markets perspective, we add a few more metrics, the salient one being valuations.

So are we really decoupled, and if so, what does that mean for an investor like you?

Let's look at the basic theory in simple terms first.

Nudging the psychological barrier of 20,000, the Sensex on a 2010 YTD basis has out -performed not only the developed equity markets but also most of its Asian peers. Which is why it theoretically seems that the Indian markets have decoupled from other global markets.

Now, what is it that leads to this decoupling - the structures of the economy or is it the relative movement of various financial assets that gives birth to the theory of decoupling?

I think it is a clear divergence of economic variables that drive economies that leads to decoupling. In the Indian context, given the macro structure of our economy and the growth momentum it is witnessing, we believe that the domestic consumption pattern and investment needed to support the dynamics of growth will keep the Indian economy nudging ahead and hence decoupled from its western counterparts.

The other factor is the movement or maturity or even potential of the assets that a country, especially a growing country like ours, has to offer. I would tend to believe that decoupling of returns profile of asset classes of different economies is one of the elements of the whole decoupling theory. Financial assets mirror the state of economic health of any country. So similar asset types in different countries may behave differently at a point of time. Of course, one should remember that for India there is one limitation as it is coupled in terms of fund inflows and availability of global liquidity.

Indeed history bears testimony to the theory of decoupling. Consider this. The big boom in the US stock markets right through the 1990s corresponded with the big decline in the Japanese stock markets and the economy. The Dow went up from 1938 at the end of 1988 to 11500 by the end of 1999. The Japanese markets fell from 39000 at the end of 1989 to 19000 at the end of 1999.

Further, liquidity gushing in or flowing out can sometimes exaggerate the decoupling process of financial markets. In 2007-08, when the huge flow of liquidity into India led to its out performance in late 2007, other equity markets faced steep corrections. Again, throughout 2008, in the wake of massive FII outflows, broader indices again coupled with the trend in other equity markets and decoupled from the strength of its fundamentals.

So that was the theory, revisited in a sense. And so it raises two fundamental questions. One, what should we expect in India? And two, most importantly, what should we do as investors?

On the first one, the decoupling theory is certainly alive and kicking. And I would expect it to be so well into the foreseeable future, both in economic growth and also in equity market movements. India has in the last 4-5 years grown at a robust pace and still holds promise and potential at least for the next decade. The key drivers being: Infrastructure, key for a robust and sustainable level of GDP growth; a high savings rate, which should be highly instrumental in driving the engine of a consumption-led growth story.

Moreover, domestic flows are currently lower when compared to international flows, leading the market to dependence on foreign flows. On this front the decoupling has some way to go, the way the economy has. However, this simply means that as and when domestic flows strengthen, it may lead to further decoupling. With the changes in the investment patterns of Indians and the social changes that we are witnessing, the domestic savings will find more ways to fuel the capital markets.

Now on the second one, on what should we as investors do? Here let's get to bullet points.

Let's take advantage of the India growth story. We must not miss this opportunity. So let's increase our participation in the markets. After all, we are talking of large tracts of time, and markets are volatile only in the short term. So basis our goals and our risk appetite, lets wet our feet Since we are neutral in the short term and overweight over a horizon of over a year,   this means we are building a portfolio by end FY11, when the markets may not look expensive after factoring in the FY12 earnings. So let's buy on dips. The question is, how do we do that in a disciplined manner? The answer is, through this new product called 'Equity SIP'. Now you can choose a certain stock and keep buying it SIP (Systematic Investment Plan) style. Rupee cost averaging comes into play. You fix the amount (you may choose to fix the numbers of shares if you so desire) and if the price is high, you end up buying less and if it is low, you end up buying more. How's that for buying on dips? With the markets near highs we would suggest you hold back lump sum investments   for the moment and adopt the SIP (Systematic Investment Plan) route. Invest regularly to capture the movements in the market Balance your portfolio with a healthy mix of large and mid caps. Remember mid caps   are future large caps. The difficulty is in making a choice. So just lean on our research for this and go the SIP way It's not so complicated actually for a disciplined investor, who invests regularly and uses research.