By Amitabh Tiwari & K Shankar
Are you a trader in the stock markets? If yes, you might have watched the trade set up broadcast by several business channels in India in the morning before the market opens.
One of the regular themes discussed in these shows is how the United States markets performed the previous day. On that basis, how Indian markets would behave during the day is predicted.
Whenever the benchmark equity indices in India rise or fall, invariably the first reference is made towards how the US equity market performed. So if the US markets rose yesterday, then it is assumed that Indian equity markets will also rise today, and if the US markets fall, Indian markets will follow suit.
This is how the US and the Indian markets have behaved during the past 15 years. In 2020, while the S&P 500 has increased by 1.8%, the NIFTY50 has increased by 0.71%.
There is a general consensus among experts and participants that the S&P 500 closing and only the Nifty 50 opening are correlated. They believe as the day progresses and the news of India starts trickling in, the NIFTY50 gets adjusted accordingly.
To validate whether there is any correlation or not, we have conducted a correlation of daily data of S&P 500 and Nifty 50 indices over the last 15 years. The year wise correlation of both Nifty’s opening as well as closing index levels with the S&P 500 is captured below.
Note: High: 0.75 & above, Medium: 0.5 to 0.75, Low; 0.25-0.5 and No correlation: 0 to 0.25
One can conclude from the data above that there is positive correlation between S&P 500 and Nifty 50 Opening. Not only Opening there is positive correlation with Nifty Closing as well.
It is also important to note that both the Nifty opening and Closing levels have almost identical correlation levels. This means if S&P 500 had risen yesterday and if today’s Nifty50 has opened higher, then there is a very high probability of Nifty 50 closing higher as well and vice versa.
It is evident from the table that 60% of the time there has been high correlation between the indices.
In 9 out 15 years the correlation has been greater than 0.75.
In 3 out 15 years the correlation has been medium, between 0.5 to 0.75.
In 3 out 15 years the correlation has been low, between 0.5 to 0.75.
In none of the years has there been no correlation at all, nor negative correlation.
In the last 5 years from 2015-2019, we have had one year of low, and two years each of high and medium correlation. In 2020 YTD, the correlation is high at 0.87.
So if you are a day trader, it will be worth you time to have a look at what happened in US markets yesterday while defining your trading strategy for the day.
If you are a long term investor you shouldn’t worry much about day to day movements anyways.
Also, it would not be prudent to compute correlation of the two indices on a cumulative basis. This is reflected in the above table. While here too, the number of high correlation years is only 8/15 (compared to 9/15 individual years), but the vagaries of an individual year is lost in this kind of comparison.
Due to legacy years taking predominance, the short term phenomenon does not get captured. This we fear would hamper decision making as more and more years get added.
“The emerging markets including India remain closely linked with other developed markets and especially the US. For example, even a cursory glance at overnight movement S&P 500 or Dow Jones is enough to see their impact on Asian markets when they open next morning. This can invariably be seen in SGX Nifty and then later in Sensex and Nifty too. This happens because of close linkage between global financial markets,”says Pankaj Sharma, Partner at EMAlpha, a firm focused on use of unstructured data for investment decisions in Emerging Markets.
To conclude, while there is a positive correlation between S&P 500 and Nifty 50 indices, both on opening as well as closing, this has occurred, on an annual basis, with a high degree only in the past 9 out 15 years.
Traders in India are more likely to benefit if they track closely Nifty's opening and previous day's S&P 500 closing and accordingly undertake intra-day trading positions.
Amitabh Tiwari is a former corporate and investment banker turned political commentator and strategist. He tweets @politicalbaaba.
K Shankar is a MBA in finance with over 2 decades of experience in equity research and financial analysis.