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Why A$/C$ cross currency rate may matter for Sensex

Why A$/C$ cross currency rate may matter for Sensex
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First Published: Wed, Mar 30 2011. 08 58 PM IST
Updated: Wed, Mar 30 2011. 08 58 PM IST
On 17 March, BCA Research, a well-known independent global research outfit, said that investors should resist the temptation to look for bargains among emerging markets, although the sell-off in emerging equities relative to developed market equities seems to have abated. The rotation away from emerging markets has been a hot topic ever since fears of higher inflation in emerging markets, coupled with higher growth in the US, led to emerging markets underperforming developed ones since last November.
The renewed inflow of foreign institutional investor money into equities has led to speculation that perhaps the rotation is now at an end and it’s time for money to flow into emerging markets once again.
Also See Emerging Markets’ Share of world M-cap (PDF)
Data from EPFR Global, the fund allocation tracker, do not show any big changes in outflows, but then the data available so far is up to the week ended 23 March—much of the action in the Indian markets has happened since then. As EPFR Global puts it in its latest missive, “Investors are apparently wondering how the combination of high energy prices, appreciating currencies and rising inflation will affect the growth prospects, policy choices, and investment climates of these markets.”
Nevertheless, emerging markets have done much better in March—the MSCI Emerging Markets Index is up 3.1% this month, as on 29 March. MSCI India is up 8.6%. In contrast, MSCI USA is down 0.5% and MSCI Europe is down 1.7%. That’s a nice change from the earlier performance from the point of view of emerging markets.
Analyst reports now increasingly suggest that the selling in emerging markets has been overdone. For instance, a Citigroup report by its Asia equity strategist Markus Rosgen says the growth deceleration worry about Asia is just a scare and their leading economic indicators point to strong growth in the region.
So why did BCA Research say the outperformance of emerging markets against the US is not sustainable? One of the indicators it looked at was the cross currency rate between the Australian dollar (A$) and the Canadian dollar (C$). The A$/C$ cross rate, pointed out BCA, “correlates with emerging markets’ relative performance and it does not point to an imminent uptrend either. The rationale is that CAD (C$) is more exposed to trends in the US economy while the AUD (A$) primarily reflects tendencies in the Chinese/emerging Asian economies”.
The correlation of A$/C$ with the Sensex is remarkable. For example, A$/C$ bid rates went from around 0.8 to 0.98 between March and November 2009, according to data from oanda.com. Over this period, the Sensex rose from 8,300 to 17,000. Between November 2009 and June 2010, however, A$/C$ went down and the Sensex didn’t do anything much. But when A$/C$ started moving up in June 2010 and continued to rise till November, the Sensex followed suit, moving from 17,000 to 21,000. Thereafter, A$/C$ rate moved up and down, but reached a low in early March.
In fact, the recent bottom for A$/C$ was on 18 March, while the BCA report is dated 17 March. Since 18 March, however, A$/C$ has moved sharply up. That has coincided with the bounce in the Sensex. The A$/C$ rate, therefore, may be an indicator for the Sensex, and one has to keep a close track of any changes in direction.
Graphic by Yogesh Kumar/Mint
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First Published: Wed, Mar 30 2011. 08 58 PM IST