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| Investing on the basis of IIP? |
| Devangshu Datta / New Delhi Jul 18, 2010, 00:43 IST |
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You need to be more cautious because of the quirks of the industrial production index.
The index of industrial production (IIP) is a mysterious official statistic. It confounds as often as it enlightens. Traders, who know little about the construction of the Index of Industrial Production, go long if it’s risen and short if it has dropped.
IIP is a pure number. The Ministry of Statistics and Programme Implementation tracks manufacturing, electricity and mining. It weights activity in the ratio of roughly 80 per cent for manufacturing and 10 per cent each for the other two. The sectoral activity is compared to a normalised base, where 1994-95 =100.
This is released mid-month with a 6-week lag. There’s an initial quick estimate (QE) , followed by revised (RE) and final estimates (FE). There is no seasonal adjustment. So, end-March IIP (financial year-end) always shows a big jump over February. April always slumps versus March. This is true to a lesser degree for the last month of every quarter – that is June, September and December.
This lumpy reporting leads to major volatility in IIP trends. Adjusting for that, IIP is a reasonable representation of non-agricultural GDP trends. It has higher reflection in equity because agriculture (which contributes about 17 per cent GDP) has low representation in listed businesses.
But instead of index numbers, what is generally reported is point-to-point (PtP) comparison between the index of a given month (May 2010 was the latest QE ) and the same month of the past year (May 2009). The PtP is debated with solemnity. This is the statistic that moves the market.
The PtP is based on the QE, which is subject to change. We’ve seen predictions that growth is slowing because May 2010 IIP (QE) was up “only 11.5 per cent” over May 2009. This is the eighth straight month of double-digit PtP rise (it was up 16.5 per cent in April 2010 (RE) versus April 2009).
Should you trade equity on the basis of IIP? No. Apart from lag, the construction method, and the emphasis on PtP have distortions. The Nifty is volatile but it is not lumpy. There are millions of daily data points for stock trades. Changes in equity values occur much more efficiently than with a monthly time series.
Technicians call the IIP PtP change, a “12-month Rate of Change” and while RoC is an useful momentum indicator, it is never traded in isolation. A technician who learnt that the Nifty in May 2010 was up 14 per cent over May 2009 (and up 52 per cent in April 2010 over April 2009) would want answers to several more questions before making investment decisions.
One is absolute Nifty levels. Second, was there sharp sequential growth, creating a higher base ? In fact, there was a 28 per cent rise in Nifty values of May 2009 over April 2009. Third, he may map the Nifty against a moving average of say, the past 12 months, to smooth out trends and see if the index is maintaining long-term growth.
It is not difficult to answer similar questions with reference to the IIP, either. But convenience trumps rigour and nobody does this in a transparent, publicised way. Even pundits don’t make caveats when talking about PtP.
The IIP was at 280 points in May 2009 and 269 for April 2009 – a sequential change of 4 per cent. The QE for May 2010 is 312.5, while RE for April 2010 is 313.7. March 2010 saw an End-of-year surge to 348.5 from 318.5 in February 2010. April saw the usual slump.
The 12-month moving average is 310, which means May 2010 is above the trend growth rate. The 3-year CAGR was 5.6 per cent in May 2009. It is at 5.9 per cent in May 2010. Those numbers don’t suggest slow-down. They indicate how misleading PtP is. A lack of seasonal adjustment makes it difficult to trust regression analysis but that doesn’t suggest slowdown either.
There is some correlation between IIP and the Nifty but hardly enough to trade. I'll predict with high confidence, that when the June 2010 QE is released (in mid-August), it will show a surge over May 2010. This will be followed by a small slump in July 2010 QE, over June 2010 in mid-September. That’s a statistical quirk of the IIP calculation method.
I'd be much more cautious making similar assertions about Nifty values because those are determined by continuous trading. If you wish to trade equity on the basis of IIP, do so in the awareness of the IIP's quirks. What you see reported in PtP terms, is not what you get in terms of trend growth.
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