Monsoon & Markets What’s The Connection?

In what can be termed a worrisome event, the markets continue to remain jittery and volatile as the global events unfold like the many layers in a bale of cloth. And with the Q4 results’ seasons almost coming to an end, the focus now shifts to another major factor viz. the monsoon season. After last year’s deficient rainfall – the worst seen in four decades - it is but obvious for investors to keep a close eye on the rain forecasts as it not only affects agriculture but also has an impact across all sectors of the industry.In fact, with food inflation reaching a peak of 19.95 per cent and still hovering above 16 per cent (the highest seen in the last 11 years), the issue is indeed gaining serious proportions. Thus, the monsoon forecast does acquire more significance this year.

An initial forecast from the India Meteorological Department (IMD) has predicted a normal rainfall for the year 2010 at 98 per cent of the long period average of 89 cms (the second stage of the forecast is expected in June 2010). The department calls a monsoon season ‘normal’ when the total amount of rainfall in the country between June and September is within 19 per cent (plus or minus) of the average rain over a long period. While this could have indeed cooled many a nerve in the government as regards economic growth, there is indeed one question that comes to our mind. Though monsoon is one of the major triggers from an economic perspective, does it really hold a similar importance when it comes to the stock market or is it an indicator that is just being overrated by the market over the years?

In a bid to find an answer to this, we plunged into a heap of data of not only the rainfall and Sensex over the last ten years, but also went a step ahead and studied inflation, agricultural growth and GDP growth to understand the impact on the economy as a whole. And our analysis has brought to the fore some startling discoveries.

But before we move ahead, let us clarify a myth. Barring FY10, when we witnessed deficient rainfall of 77 per cent, India has always received normal monsoon for almost two decades. So if that is the case then it should be safe to assume that the data shouldn’t throw up any odd surprises.

But, having said that, India still looks forward to the rain gods smiling upon us every year considering the fact that agriculture employs more than 60 per cent of the population. And while it could be but obvious for anyone to assume the significance of the monsoon as an important factor on the stock markets, our data surprisingly indicates otherwise. In fact, when we compared the Sensex performance during the monsoon period (June – September) and rainfall since 2001, there hardly seems to be any correlation.

Just to cite an example, in 2001 and 2002 the shortfall in rain was about 9 per cent and 19 per cent. However, the Sensex, though dipped, was down by 23 per cent and 5 per cent respectively. If there had been a correlation then more the rainfall deviation in a particular year, the greater would be the fall in the Sensex. But that doesn’t seem to be the case here. What surprises us more is that in 2004, 2005 and 2006, despite the country having faced lower rainfall than the LPA, the Sensex was still up by 17 per cent, 17 per cent and 24 per cent respectively.

It should be noted that the Sensex data is for the monsoon period and not the full year and still it fails to show any impact of the rains on its performance. If that wasn’t enough, in the last fiscal - that saw a shortfall in rain of 23 per cent (the worst monsoon in 40 years) - the Sensex still managed to climb 7.80 per cent during the same period. This clearly indicates there isn’t a direct correlation between the monsoon and market performance and there are indeed other factors that do play a major role on markets other than the quantum of rain.[PAGE BREAK]

Taking into consideration the benefit of doubt, we went ahead and compared the rainfall data to WPI and food inflation. Though theoretically there should be correlation between these factors, we see mixed results. In FY10, while we witnessed deficient rains of 77 per cent, the food inflation was at 14 per cent. However, considering the second and third worst rainfall witnessed in FY03 and FY05, the food inflation was surprisingly at its lowest at 1.76 per cent and 2.64 per cent. In fact, looking at the opposite scenario where despite FY99 witnessing above average rainfall, the food inflation was at 12.73 per cent - the second highest spike seen in the last 11 years - we don’t see a correlation here either. The other factor that we believe may be stealing the thunder out of monsoon is the quarterly results.

It should be noted that when the rains start in June, it’s the start of the results season for corporate India as well. Considering the fact that the first quarter results are important as they set the tone for the remainder of the fiscal, investors probably might be focusing more on them than the monsoon. If that wasn’t enough, while the rains peak during the period and come to an end in September, investors are busy anticipating the second quarter results of India Inc instead of taking stock of how the monsoon had been. Thus the results might indeed be overshadowing the monsoon impact.

But one thing that cannot be ruled out is that the monsoon does have an economic or GDP impact This could be seen from the fact that whenever the rains have fallen below the quantum of the earlier year, it has hurt agriculture growth and in turn impacted GDP growth. Therefore, barring FY10, which was the year of a stimulus-aided economic bounce-back, FY03, FY05, FY09 etc have shown that when the rains fell lower than prior years, agricultural growth has either remained stunted or even dipped, thereby leading to a corresponding fall in the GDP. And this has happened despite the fact that the agriculture weightage in GDP has been consistently falling over the years.

However, Ajay Jaiswal, President (Research & Investment Strategies), Microsec Capital, who is optimistic about the monsoon this year, feels, “Farmers know that the food prices are quite high this year and so they plough each and every corner of the field. Besides, they now have easy access to credit and at lower rates. All these factors are not visible, and cannot be explained empirically, but they play a major role and so if the monsoon is good, it will propel growth at a faster rate than what has been witnessed over two to five years ago.”