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The rupee correlation: Its impact on markets

By Mukul Pal in New Delhi
October 01, 2007 09:56 IST
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There's a lot of talk about how a currency affects the stock market and the economy. There is even literature available on the dollar and its beneficial effect on the Dow.

A strengthening dollar is considered good for Dow components. The top 30 companies of the world have operations around the world and payables in dollar. Thus, a strengthening dollar is hence considered positive for Dow blue chips.

Not a very different story connects the rupee with the Sensex and the rupee with Indian tech sector. A stronger rupee hurts exports and a weaker rupee benefits. Now this is about perception and theory.

A real correlation check on how strong these correlations are reveals a different picture. Dollar-Dow correlation oscillates from positive to negative and not surprisingly the correlation of the rupee with the Sensex or CNX IT is also weak. The reality, just like always, is different from perception.

This is another economic rule which markets trash. We talked about the spin effect on currency last time. The reality of rupee proved us right again as the rupee broke the 40-mark. The story should now be that foreigners want to assume currency risk as local currency is strengthening against the dollar.

Being invested in Indian stocks is a haven as both the Sensex and the rupee go up. This is a double benefit. But unfortunately even foreigners are human and as a group go wrong. Their investment strategy was weaker in Jun 2006 (rupee at 46.5), but it's stronger now that we hit 39.

Correlations are make-believe, there is no clockwork here. They cannot tell you where the rupee is headed and where it will take the Sensex with it.

The big surprise always happens when people least expect it. We don't see the rupee appreciating beyond 38, it's a turning point for us. And we are not far from a dollar surprise as it turns around for a multi-month of strengthening.

And about the Sensex, the immediate price targets lie at the Fibonacci confluence of 18,000 points despite what the rupee does and without health care, FMCG, auto and IT, which still reel under or near May 2006 highs.

The positive correlations of yesteryears of these four sectors with the Sensex are turning sour now.

Contributed by Orpheus Capitals, a global alternative research company

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Mukul Pal in New Delhi
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