Do markets take economic cues?

What do macro indicators say for the stock markets in the year ahead? If the stock market revival in 2009 provides any clues, it is that markets do not wait for production activity to revive before taking off. They move ahead of its turning points.

Take the IIP. In 2009, stock markets bottomed out in March and began the upward journey. The IIP had been contracting for three months then and continued in this vein for three more months after markets began to rally.

With two-thirds of the BSE 500 companies which account for over 90 per cent of market cap being manufacturers, the IIP, despite its month-to-month swings, does carry a high linkage to the fortunes of listed companies.

When it revives there is generally more optimism. And this may be a key to business confidence.

But the above trend is not true of other indicators, such as inflation and interest rates. Markets have preferred to wait and watch these vital statistics before responding. In the last correction, while inflation cooled off in October 2008, markets remained sideways for at least five months before rallying decisively in March. A similar trend was visible with interest rates as well.

This could be because the effects of a dip in inflation and interest rates are felt only much later by the companies. Experience suggests a 3-6 month lag before companies experience the benefits of falling commodity prices or of about 18 months for interest rates.

Moving to the current scenario, IIP has just started contracting and interest rate cuts seem a while away. It is perhaps this uncertainty that is making the markets meander without direction, waiting for vital cues.

Slowing inflation, for now, appears to be the only reasonably positive indicator for markets.

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