Boom and recession are the two words which have got fairly large coverage of media as the people became aware of economic growth and its impact of their life. Paul Craig Roberts once told “The road to economic well-being is to reward productive economic activity and to provide a moderate and predictable growth of money to finance real economic growth without reigniting the fires of inflation.” As an Investor, you always want to track economy to assess the probability of growth in investments made in financial assets. Question is “what is the simplest way to understand whether economy is growing or not? ” Answer is to start tracking major stock market indices which reflect economic health of a country. Stock market index is a single value arrived after calcualtion of growth or decline in price of stocks which are inclded to construct it. Index is a basket of stocks whose value is derived from the weighted price movement in value of stocks which are selected in baseket based on certain methodology. Methodlogy can be various from giving equal weight to weight as per floating market capitalization of companies. In India, Sensex (BSE) and Nifty (NSE) are two major indices tracked by maxium number of investors. Ofcourse, there are other indices also,like MSCI India Index or SX40, but they are popular among limited number of sophisticated and well informed investors like HNIs, mutual fund, foreign portfolio investors and domestic instiutional investors. Now the question comes “Which index should be tracked to understand the ecnomic growth?” Answer is the index which represents all sectors of economy and has broader participation of companies. Sensex is made up of 30 companies (12 sectors) where as Nifty is made up of 50 companies (13 sectors). Are 30 or 50 companies enough to judge the economic condition of whole country or the sentiment of stock market activity? Answer is subjective with 2 sides of the coin. These 30 or 50 companies are large cap companies selected from major sectors of economy but included in the index on the basis of their free float market capitalization. You can generalise that if these 50 large companies are doing good which means economy is on expansionary path. Coming to the second side of coin, these large companies do have benefits of economy of scale, sophsiticaed technology, globally spread business, easy access to credit and preference from government for large scale projects and exports. On the other side, mid and small cap companies are having disdavatange on one or more than one of the benefits mentioned above. These companies may do bad because of some of the disadvantages. It may also happen that maximum companies from a sector with high market capitalization can become part of Nifty or Sensex. Infact, in present situation, financial sector is getting major weightage (39% in Nifty and 35% in Sensex) in calculation of major indices. Tracking movement of Bank Nifty index will tell you how much influence it can have on major index. So, it may present a distorted reality about economy when 2 or 3 sectos with high weightage (4 sectors make 80% weightage of Nifty) can take index to higher or lower level. Coming to the second side of coin, suppose banking is doing good that means economic activity is in expansionary phase beause of credit growth. Is this credit is reaching to every sector and companies (large, mid and small) of the economy or bank are reluctant to lend to some sectors or companies ?

Solution to this situation is to track broader indices like Nifty 200, Nifty 500, S&P BSE 200 or S&P BSE 50 in addition to major indices. These indices consist of companies selected from large cap, mid cap and small cap universe. You will have fair idea of what is happening in all sectors and companies of different strength of Indian economy. If you see divergence in the movement of major indices and these broader indices, then you will be in position to generalise at the first look that something is suspicious on broader scale. Sherlock Holmes within you must start probing deeper in sector and capital specific indices to know which are under or out performing. Relative strength comparison (index/index, sectoral index/ major index, stock/sectoral index) will help you to decide which index, sector and stock are likley to peform and will give you fair knowledge of what is happening in economy.