The year 2008 has been disastrous for the global markets and for global economies as the deflation fears have established firmly in the minds of people. Economists and Policymakers are debating the methods of Keynes and the events of 1930s are helping to drive policy action.
Thanks to the "learnings" from that period current actions have been more comprehensive, co-ordinated across nations and are promising. However, as we have seen, each crisis has different ingredients and hence the solution must be different. It appears that policy makers are preparing for a situation where there arsenal is powerless, increasingly, and thus we now have a recession with a potential reversal not before calendar 2010.
In the new year the challenges that the world faces would come from emerging markets - in fact those challenges are already visible. Bric economies have begun to slide down and this unravelling has been a major learning from this crisis. In an inter-connected world crises travel across countries. Yet, given their high growth rates and an inherent desire of their populations to grow their Per Capita incomes, new hopes are rising that the emerging markets, especially the Bric economies could be the accelerators and help the developed world to climb up the hill. The trouble with this argument is the lack of sufficient domestic investment in emerging markets and their dependence on exports to the developed world. The world cheered as these economies became the new factories producing cheap goods for the developed world and helped control inflation but the world is now surprised that those economies cannot become the providers of demand or help take up the slack that arose from the slowdown in advanced economies. Hopefully, coordinated action that we are seeing from the emerging economies will help to slowly bring about a quiet recovery. If they fail this recession will be much harder on the developed economies.
We can now also see why a prediction for the dollar has become difficult - if the US is to come out of the mess it needs to export some stuff to other countries (who in turn would have to generate demand). Its currency yields next to nothing. Such conditions ideally bring about a reversal to recessions. A fear of deflation seems to be now haunting everyone which along with the unwillingness of lenders to give money to anyone is hitting credit markets. The other developed economies (with the exclusion of Europe where a major slowdown is some months away) results in the danger of all of them being put into one basket. So, on the twin scales of returns and growth, it would appear that the US should suffer in short-term and show promise in the longer term. However, the fall in long term yields (nominal and inflation-adjusted) promise no long term growth prospect!. So, as you can see the equations do not match up. And hence the state of markets. Hoefully, the new year will throw up some leads and help markets to decide which way to go.
PS: Apologies!I could not update the blog last week. The breakdown/slowdown of the net was one reason while my laziness was the other reason.
Sunday, December 28, 2008
Sunday, December 14, 2008
Negative Yields?! Everything is possible now
This week for the first time since the depression of 1929 the yields on US Treasuries turned negative i.e., investment in such Treasuries would pay back a lower amount on maturity. The three month Treasury bills gave a return of negative 0.005 pct. As the Treasury yields plumbed new lows the credit spreads of high-investment corporate papers worsened further. Spreads have actually doubled during the last 9 to 12 months reflecting the fear factor. CDS on Sovereigns have increased 8-10 times even for G7 countries during the same period!. Net of such spreads yields have dropped to ridiculously low levels reflecting the starkness of fear which is pervading in the world today. Certain indicators such as TED spread which is now at about 2 pct and yields on 30-day Commercial paper (at below 1 pct)etc seem to suggest that the liquidity overhang was helping to bring in some relief and credits were able to access better rates. However, the negative yields on Treasuries threatens to upset the improvement in the markets.
Madness or Fear -
November saw the dividend yield on S&P Index overtake the yield on Treasuries for the first time since three decades showing up the extreme pessimism that has set into the credit markets. This week brought in negative nominal yields after almost
8 decades reflecting the extreme fear prevailing in the market.
The week also saw the evaporation of any residual hopes that Automakers in the US had of a Federal Bailout as the Senate decided that Bankruptcy was afterall not a bad option for the Big Three. The Executive Wing had to immediately step in to promise its support from the TARP in another example of the twists and turns that the programme has been subjected to. It has evolved into a programme that was targeted at purchasing trouobled assets but has actually provided capital/funding to the banking sector and is now addressing the funding constraints of the auto sector. The prospect of use of TARP funds for the Autosector has helped recovery of global markets on Friday.
This episode is the latest one in the series; there will be more to come. This episode which has taken weeks to reach the current stage, shows that governments are increasingly being forced by markets to intervene and support industries. Unfortunately, all these measures seem aimed at supporting the supply side. Markets have anyway decided that this measure is a short-term fix and has a good chance of ending in zero improvement unless the US economy stablises or the Government follows up with more wholesome measures (covering the entire economy). However, the problem is on the other side where consumers fear losing livelihood and bankruptcy (and foreclosures due to inability to service their mortgages). It will take time for the demand side to revive. Until then, pushing the supply side can only worsen the supply/demand equation and lead to pricing weakness to exacerbate.
Currencies
Finally, the week saw the EUR and GBP reverse from their lows. After straining for weeks, on Friday, the Japanese Yen managed to break through the 90 barrier against the Dollar after news of failure of Auto bailout by the Senate hit the market and reached a 13-year high of 89. The move from 91.50 was worth more than 2.50 pct but the move exhausted within the day itself. A move of 3 pct is counted as a large move in the markets. However, the reversal came not from any BOJ intervention (as many had been hoping for sometime), but by the assurances of the US Administration that it would use TARP funds to organise the bailout. The move in the Jap Yen, the mother of all carry currencies on the back of the failure of the Auto bailout as well as the reversal on news of infusion of TARP funds suggests that nerves are really frayed at this stage. But, the key input for markets was the apparently nonchalant reaction of the Japanese to the fall in USD/JPY. Does this mean that we do not have a line in sand any longer? For all those holding long USD/JPY positions on derivatives, or running Yen denominated loans nothing could be more worrisome than this. We need to watch for markets' reaction on Monday. However, if the reactions of equity markets on Friday (in London and US) are any indications, it seems that the break down of the USD/JPY may take some more time.
Meanwhile, the nice rally in EUR/USD helped pull up commodities. EURO is close to resistance zone, so this week's action is important as we run into Christmas holidays from next week. The action on emerging markets' currencies has been a little mixed with the Korean and Russian currencies showing some weakness while many other currencies have strengthened along with stock markets.
The recent moves, with small rallies adding to each other, suggest that we are in the midst of a bear market rally. Equity markets are likely to lose when the quarterly results begin to come out. With all countries (that count) effectively in recession, or suffering from big drops in GDP growth rates there is no way that a rally in equity markets can be sustained so soon. More pain is on the way.
Madness or Fear -
November saw the dividend yield on S&P Index overtake the yield on Treasuries for the first time since three decades showing up the extreme pessimism that has set into the credit markets. This week brought in negative nominal yields after almost
8 decades reflecting the extreme fear prevailing in the market.
The week also saw the evaporation of any residual hopes that Automakers in the US had of a Federal Bailout as the Senate decided that Bankruptcy was afterall not a bad option for the Big Three. The Executive Wing had to immediately step in to promise its support from the TARP in another example of the twists and turns that the programme has been subjected to. It has evolved into a programme that was targeted at purchasing trouobled assets but has actually provided capital/funding to the banking sector and is now addressing the funding constraints of the auto sector. The prospect of use of TARP funds for the Autosector has helped recovery of global markets on Friday.
This episode is the latest one in the series; there will be more to come. This episode which has taken weeks to reach the current stage, shows that governments are increasingly being forced by markets to intervene and support industries. Unfortunately, all these measures seem aimed at supporting the supply side. Markets have anyway decided that this measure is a short-term fix and has a good chance of ending in zero improvement unless the US economy stablises or the Government follows up with more wholesome measures (covering the entire economy). However, the problem is on the other side where consumers fear losing livelihood and bankruptcy (and foreclosures due to inability to service their mortgages). It will take time for the demand side to revive. Until then, pushing the supply side can only worsen the supply/demand equation and lead to pricing weakness to exacerbate.
Currencies
Finally, the week saw the EUR and GBP reverse from their lows. After straining for weeks, on Friday, the Japanese Yen managed to break through the 90 barrier against the Dollar after news of failure of Auto bailout by the Senate hit the market and reached a 13-year high of 89. The move from 91.50 was worth more than 2.50 pct but the move exhausted within the day itself. A move of 3 pct is counted as a large move in the markets. However, the reversal came not from any BOJ intervention (as many had been hoping for sometime), but by the assurances of the US Administration that it would use TARP funds to organise the bailout. The move in the Jap Yen, the mother of all carry currencies on the back of the failure of the Auto bailout as well as the reversal on news of infusion of TARP funds suggests that nerves are really frayed at this stage. But, the key input for markets was the apparently nonchalant reaction of the Japanese to the fall in USD/JPY. Does this mean that we do not have a line in sand any longer? For all those holding long USD/JPY positions on derivatives, or running Yen denominated loans nothing could be more worrisome than this. We need to watch for markets' reaction on Monday. However, if the reactions of equity markets on Friday (in London and US) are any indications, it seems that the break down of the USD/JPY may take some more time.
Meanwhile, the nice rally in EUR/USD helped pull up commodities. EURO is close to resistance zone, so this week's action is important as we run into Christmas holidays from next week. The action on emerging markets' currencies has been a little mixed with the Korean and Russian currencies showing some weakness while many other currencies have strengthened along with stock markets.
The recent moves, with small rallies adding to each other, suggest that we are in the midst of a bear market rally. Equity markets are likely to lose when the quarterly results begin to come out. With all countries (that count) effectively in recession, or suffering from big drops in GDP growth rates there is no way that a rally in equity markets can be sustained so soon. More pain is on the way.
Sunday, December 7, 2008
Strategies for current times
I find that more and more people are puzzled by the Dollar's strength amid the recent global volatility.
I am one of them - the sub-prime crisis originated in the US, the twin deficits are largest in the US, its unemployment is almost 7 pct, its banks are on oxygen supply, its manufacturing and GDP is in shambles. And, the median expectations suggest a depression lasting the full of 2009.
On the other hand, the Eurozone has smaller deficits though it is facing a similar problem on GDP and unemployment. Many OECD countries are passing through a bad phase.
Yet, the dollar has continued to strengthen relentlessly. Recently, though it seems to be forming a top. I would suggest that the dollar's strength is creating for the US economy. When and how would the dollar weaken? We have reached the possible end of monetary policy ammunition of the US - on Dec 16, the Fed could cut rates by upto 75 bp as per median expectations. Liquidity has been flooded into the markets. On the other hand the new evidence from data suggests that the recession is going to be longer and a return to normal conditions before growth has a chance will have to wait till the end of 2009.
Thus, some of the above could impact the dollar negatively - low bond yields may dampen dollar investment flows, Countries with excess current account surpluses are not opening up their borders to imports which could hit the US more than others, the Treasury bonds may turn unattractive due to their low yields and low real yields, a big rise in deficit could bring about a selloff in bonds due to inflationary expectations.
Companies that have non-dollar exposures may look at hedging these.
I am one of them - the sub-prime crisis originated in the US, the twin deficits are largest in the US, its unemployment is almost 7 pct, its banks are on oxygen supply, its manufacturing and GDP is in shambles. And, the median expectations suggest a depression lasting the full of 2009.
On the other hand, the Eurozone has smaller deficits though it is facing a similar problem on GDP and unemployment. Many OECD countries are passing through a bad phase.
Yet, the dollar has continued to strengthen relentlessly. Recently, though it seems to be forming a top. I would suggest that the dollar's strength is creating for the US economy. When and how would the dollar weaken? We have reached the possible end of monetary policy ammunition of the US - on Dec 16, the Fed could cut rates by upto 75 bp as per median expectations. Liquidity has been flooded into the markets. On the other hand the new evidence from data suggests that the recession is going to be longer and a return to normal conditions before growth has a chance will have to wait till the end of 2009.
Thus, some of the above could impact the dollar negatively - low bond yields may dampen dollar investment flows, Countries with excess current account surpluses are not opening up their borders to imports which could hit the US more than others, the Treasury bonds may turn unattractive due to their low yields and low real yields, a big rise in deficit could bring about a selloff in bonds due to inflationary expectations.
Companies that have non-dollar exposures may look at hedging these.
Sunday, November 30, 2008
Correlation - Dollar and Stocks
An eventful week has passed by. The Dow has seen a strong rally not seen in decades and Mumbai has seen its deadliest terrorist attack. The patience of Mumbaikars is wearing thin and the country has rallied to comfort Mumbai. Hopefully and finally, we may see action to stop this type of senseless violence.
Markets -
The BSE Midcap is now 28% of the all - time high, seen at the beginning of January 2008. The SENSEX is 42% of its all-time high seen almost at the same time.
The relative outperformers have been the Healthcare companies (such as Pharma Companies and Hospitals-they fell only about 38%) and FMCG companies (such as Britannia, Colgate, ITC etc -they fell only about 25%).
The Aut, IT,PSU, Metal,Realty and other sectors fell significantly and are the underperformers by a wide margin. Here companies got hit by the fall in demand,leveraging. They were also significantly overvalued and had to give up their excesses. Another practical way to look at the differences in performances is because the Healthcare and FMCG companies were well established companies which were, with exceptions, sticking to their knitting and conservative in their approach to expansion. The underperformers indulged in excesses - borrowing and spending recklessly (since this happened even during the time when the boom was clearly coming to an end-remember Tatas?).
A look at the markets across the globe reveals that this recklessness was widespread. The evidence that we have in India will look like a reflection of what has happened elsewhere. All this is known today.
The interesting question is this - if India was turning attractive in the last few years which explained the high share prices, then why the great fall in share prices? A plain practical (cynical?) answer is that this is the business cycle, the boom and bust of stock market. But, unlike earlier episodes, the economy has also kept up a nice growth rate. Indeed, until 2008-09 brought upon us the problems from faraway lands, policy makers were talking about grabbing double digit growth.
However, I think this time it is different. I mean the growth story is for real (though it may have been sown by excesses or it may have sown excesses!) and the Corporate sector has become better (as I keep saying). It is different because of increasing local demand and this potential is being well protected as the Government comes out with fiscal and monetary steps. The economy is still promising.
At the current levels of stocks the PEs are about 11 while dividend yield is getting closer to 2 pct. Both are recent low and high respsectively suggesting a bottom is close.
Meanwhile, the currency markets are exhibiting diverse behaviour - the dollar has strengthened back to its recent highs while the Yen (that carry currency) is trying to regain strength. An attempt at reversal of the dollar strength is now visible on the charts. This coincides with a few other reversal attempts and thus demands our attention - the money and credit markets are showing some signs of life, the Dow had one of its large rally in decades(in percentage terms). Across the world fiscal and monetary steps are being taken and these are market friendly.
For India, a small additional evidence is in the form of the decreasing sales from FIIs. This indicator has been very important. So, if the recent behavious of market is analysed from the perspective of FII activity, a bottom can now form given the other positive conditions. Of course, these are still in embryonic stage. Similarly, with the worries on US fiscal coming into the open, the dollar seems to be getting into a top.
Cheers!
Markets -
The BSE Midcap is now 28% of the all - time high, seen at the beginning of January 2008. The SENSEX is 42% of its all-time high seen almost at the same time.
The relative outperformers have been the Healthcare companies (such as Pharma Companies and Hospitals-they fell only about 38%) and FMCG companies (such as Britannia, Colgate, ITC etc -they fell only about 25%).
The Aut, IT,PSU, Metal,Realty and other sectors fell significantly and are the underperformers by a wide margin. Here companies got hit by the fall in demand,leveraging. They were also significantly overvalued and had to give up their excesses. Another practical way to look at the differences in performances is because the Healthcare and FMCG companies were well established companies which were, with exceptions, sticking to their knitting and conservative in their approach to expansion. The underperformers indulged in excesses - borrowing and spending recklessly (since this happened even during the time when the boom was clearly coming to an end-remember Tatas?).
A look at the markets across the globe reveals that this recklessness was widespread. The evidence that we have in India will look like a reflection of what has happened elsewhere. All this is known today.
The interesting question is this - if India was turning attractive in the last few years which explained the high share prices, then why the great fall in share prices? A plain practical (cynical?) answer is that this is the business cycle, the boom and bust of stock market. But, unlike earlier episodes, the economy has also kept up a nice growth rate. Indeed, until 2008-09 brought upon us the problems from faraway lands, policy makers were talking about grabbing double digit growth.
However, I think this time it is different. I mean the growth story is for real (though it may have been sown by excesses or it may have sown excesses!) and the Corporate sector has become better (as I keep saying). It is different because of increasing local demand and this potential is being well protected as the Government comes out with fiscal and monetary steps. The economy is still promising.
At the current levels of stocks the PEs are about 11 while dividend yield is getting closer to 2 pct. Both are recent low and high respsectively suggesting a bottom is close.
Meanwhile, the currency markets are exhibiting diverse behaviour - the dollar has strengthened back to its recent highs while the Yen (that carry currency) is trying to regain strength. An attempt at reversal of the dollar strength is now visible on the charts. This coincides with a few other reversal attempts and thus demands our attention - the money and credit markets are showing some signs of life, the Dow had one of its large rally in decades(in percentage terms). Across the world fiscal and monetary steps are being taken and these are market friendly.
For India, a small additional evidence is in the form of the decreasing sales from FIIs. This indicator has been very important. So, if the recent behavious of market is analysed from the perspective of FII activity, a bottom can now form given the other positive conditions. Of course, these are still in embryonic stage. Similarly, with the worries on US fiscal coming into the open, the dollar seems to be getting into a top.
Cheers!
Sunday, November 23, 2008
The Second Tsunami wave is Coming?
The tumble of the CITI stock and the questions being raised about the health of the Banking giant brings to memory the similarities with other collapses since September of this year. First the stock is jettisoned by traders amid a panic play. Then the risks that are held on and off the balance sheet are debated. Finally, the CEO's name is mud.
In this case, the cycle has been completed and its effectiveness can be seen from the way the Fed and the Treasury have been drawn into the drama. The CITI brand will be saved. What is unclear is what will carry that brand or how the animal will be transformed.
Clearly, the actions taken by CITI in the last one year have been ignored. The capital strength or its franchise/business value has been ignored. The CITI brand is valued at nothing. The fall in stock price by 50% in a week or to levels seen decades ago (when the organisation was smaller/more narrowly focussed) are attracting eyeballs. It appears that the fall in share price is driving the bank to the bankruptcy court or a merger. The enterprise value has been reworked.
There is clearly a warped sense of events here, even if one were to blame its portfolio of bonds and other instruments and assets. Except for the recent worsening of spreads on certain ABSs/Bonds etc, everything else on the balance sheet is/was the same? The fall in valuations, if it is due to genuine fresh issues/events/analysis must be the result of one or more of the following - a) the balance sheet got worse (possible due to the recession) b) fresh discovery of skeletons (speaks a lot about Auditors/Regulators) c) weak strategy (so much has been said on this, but with no clear majority or clarity of thought). None of these seem out of the recent history of ordinary in the financial sector in the world. CITI could not be suffering from more weaknesses than others.
You can see where I am leading you - the second "tsunami" wave is coming. Inspite of what CITI may do now (or may have done in the past) and inspite of all the capital that it may have (plus those billions in spare cash) nothing can stop the tsunami from running over it. If the first tsunami was linked to credit market the second one is simply a self-destructive, market generated panic that has now become omnipresent. If CITI has been targeted it is now easy to target so many other institutions - after,all they all had the same traders, risk managers and they operated in the same markets, they all paid fat bonuses and they are all listed.
Why do we have the second tsunami? I think it is just that while businesses are trying to come to terms and rescue themselves with friendly help from Government/Fed, the problems continue and the balance sheet does not get better: after all, capital can only pay for losses but unless it is deployed to expand business losses cannot be offset by fresh profits. Banks need protection from the second tsunami, not through provision of additional capital but through hiving off poor assets that have threatened to poison the entire balance sheet. Only then can the capital be put to use.
Can TARP be diverted for this purpose? Many more CITIes are in the line.
In this case, the cycle has been completed and its effectiveness can be seen from the way the Fed and the Treasury have been drawn into the drama. The CITI brand will be saved. What is unclear is what will carry that brand or how the animal will be transformed.
Clearly, the actions taken by CITI in the last one year have been ignored. The capital strength or its franchise/business value has been ignored. The CITI brand is valued at nothing. The fall in stock price by 50% in a week or to levels seen decades ago (when the organisation was smaller/more narrowly focussed) are attracting eyeballs. It appears that the fall in share price is driving the bank to the bankruptcy court or a merger. The enterprise value has been reworked.
There is clearly a warped sense of events here, even if one were to blame its portfolio of bonds and other instruments and assets. Except for the recent worsening of spreads on certain ABSs/Bonds etc, everything else on the balance sheet is/was the same? The fall in valuations, if it is due to genuine fresh issues/events/analysis must be the result of one or more of the following - a) the balance sheet got worse (possible due to the recession) b) fresh discovery of skeletons (speaks a lot about Auditors/Regulators) c) weak strategy (so much has been said on this, but with no clear majority or clarity of thought). None of these seem out of the recent history of ordinary in the financial sector in the world. CITI could not be suffering from more weaknesses than others.
You can see where I am leading you - the second "tsunami" wave is coming. Inspite of what CITI may do now (or may have done in the past) and inspite of all the capital that it may have (plus those billions in spare cash) nothing can stop the tsunami from running over it. If the first tsunami was linked to credit market the second one is simply a self-destructive, market generated panic that has now become omnipresent. If CITI has been targeted it is now easy to target so many other institutions - after,all they all had the same traders, risk managers and they operated in the same markets, they all paid fat bonuses and they are all listed.
Why do we have the second tsunami? I think it is just that while businesses are trying to come to terms and rescue themselves with friendly help from Government/Fed, the problems continue and the balance sheet does not get better: after all, capital can only pay for losses but unless it is deployed to expand business losses cannot be offset by fresh profits. Banks need protection from the second tsunami, not through provision of additional capital but through hiving off poor assets that have threatened to poison the entire balance sheet. Only then can the capital be put to use.
Can TARP be diverted for this purpose? Many more CITIes are in the line.
Sunday, November 16, 2008
Recession is on (officially!)
So it is official. Atleast 4 of the major Economies are in recession - US, UK, Eurozone, Japan. Very soon, more will join this group. The urgency shown by the Governments and by Central Banks has shown little positive results so far.
I think the speed of this Tsunami has possibly left little time for Governments to think through. Eventhough rumbles in the nature of Bear Sterns and others hit the world before September, it seems that the post September 15 events (just about 2 months) were the watershed events-the letting go of Lehman must be rankling the Fed so badly. Until October the Fed has been grappling with the fallout of the Tsunami and as the US went through an election, it has been surprisingly inert, I mean on the fiscal side. Otherwise, what explains inaction on the Auto sector; the large employment is attraction enough for a politician to act.
The US also seems to have tied itself up with TARP. The freeing up of the Credit markets in itself can only push money market rates down across. Since markets expect the Fed to reach its zero rate (0.25%) what next? In the face of the phenomenal risk aversion and as more economies tumble down and demand is destroyed, why are Governments not taking fiscal steps?
The problem is that though the problem has built up over some years and has been assuming a shape and size in the last 15 months, the full force on the economy has been felt in the last few months. The size and the regularity of the problems have surprised Governments. Central Banks, with their clear heads (and objectives of growth, inflation, employment) have moved first, obviously with helpful prodding from Governments. But, what seems to be scarce is governmental action.
It would seem that Governments are so poorly prepared to deal with something like this, individually or collectively. But, if we were to step back and have a relook it is clear that every solution is itself quite complex. Since demand is yet to be fully destroyed, and employment has not really plummeted very severely, when recession is still at the shores of advanced nations, there has been such limited steps from developing nations. The developed nations themselves are unable to break free of their capitalism - they think the steps from Central Banks are adequate. The problem is of course, deeper. Developed countries have lived off the demand from developing countries. Since the latter are beginning to suffer GDP falls, developed nations will quickly discover that pushing the string will lead to nowhere. Until markets stay in a panic mode, funds flow into developing nations will suffer and consequently the vicious circle continues. It is my guess that the way out is going to take a few quarters.
Meanwhile, if you were to analyse the above, the following ideas must appeal -
a) the dollar is possibly close to a reversal
b) emerging market currencies would have to strengthen
c) export growth from emerging economies will have to suffer
d) fiscal health of all nations will worsen; but, as it happens usually, I suspect the developing economies will have to pay more for this
e) steeper yield curves will win respect
I think the speed of this Tsunami has possibly left little time for Governments to think through. Eventhough rumbles in the nature of Bear Sterns and others hit the world before September, it seems that the post September 15 events (just about 2 months) were the watershed events-the letting go of Lehman must be rankling the Fed so badly. Until October the Fed has been grappling with the fallout of the Tsunami and as the US went through an election, it has been surprisingly inert, I mean on the fiscal side. Otherwise, what explains inaction on the Auto sector; the large employment is attraction enough for a politician to act.
The US also seems to have tied itself up with TARP. The freeing up of the Credit markets in itself can only push money market rates down across. Since markets expect the Fed to reach its zero rate (0.25%) what next? In the face of the phenomenal risk aversion and as more economies tumble down and demand is destroyed, why are Governments not taking fiscal steps?
The problem is that though the problem has built up over some years and has been assuming a shape and size in the last 15 months, the full force on the economy has been felt in the last few months. The size and the regularity of the problems have surprised Governments. Central Banks, with their clear heads (and objectives of growth, inflation, employment) have moved first, obviously with helpful prodding from Governments. But, what seems to be scarce is governmental action.
It would seem that Governments are so poorly prepared to deal with something like this, individually or collectively. But, if we were to step back and have a relook it is clear that every solution is itself quite complex. Since demand is yet to be fully destroyed, and employment has not really plummeted very severely, when recession is still at the shores of advanced nations, there has been such limited steps from developing nations. The developed nations themselves are unable to break free of their capitalism - they think the steps from Central Banks are adequate. The problem is of course, deeper. Developed countries have lived off the demand from developing countries. Since the latter are beginning to suffer GDP falls, developed nations will quickly discover that pushing the string will lead to nowhere. Until markets stay in a panic mode, funds flow into developing nations will suffer and consequently the vicious circle continues. It is my guess that the way out is going to take a few quarters.
Meanwhile, if you were to analyse the above, the following ideas must appeal -
a) the dollar is possibly close to a reversal
b) emerging market currencies would have to strengthen
c) export growth from emerging economies will have to suffer
d) fiscal health of all nations will worsen; but, as it happens usually, I suspect the developing economies will have to pay more for this
e) steeper yield curves will win respect
Sunday, November 9, 2008
What may work and what has not been done yet.
A lot of importance is being paid to Monetary Policy in Emerging Markets. This seems misplaced as I will argue below.
Most emerging markets have seen destruction of export demand to a great extent. Their stock markets have sympathetically self-destructed aping the stock markets of G7 economies. Their currencies have weakened to account for the likely pressure on the balance of payments.
The monetary steps that has been unleashed addressed the demand for dollars from stock market investors who were withdrawing investments from the emerging markets. The policies provided liquidity that was sucked out as the economy produced goods but those goods were not purchased due to demand destruction. The intention was to provide liquidity to push the wheels and gears of production.
But, in the face of demand destruction, how does monetary expansion help? Yes, in the first stage it is necessary to smoothen the market action and help production to continue. But, where is the fiscal stimulus to boost demand?One can only hope that the Governments have been busy preparing for the second step silently and hopefully they will announce the steps. We need effective steps. In India, unfortunately, we have no sign of such steps.
Until these steps are announced, I am not certain that we will see a major recovery in the stock markets. For the long term, I would recommend taking exposures on stocks with good OPM, high Dividend yield (compared to historical trend of the stock or industry), low price to book value and low PEs. Of course, selecting the correct industry is a problem. The negative list would include Auto, Auto Ancilliaries, Cement, Metals, Real Estate, Media, Shipping etc. I dont have a yes list but I would use the above rules to pick my stocks in various sectors.
It is still a risky game - we dont know how many more skeletons are waiting to come out and we dont know whether the recession will last one or two years. It seems policy makers are talking about a recession that is 2 years long. Buyers beware!. Dont expect major returns and keep a large stop. Happy hunting!
Most emerging markets have seen destruction of export demand to a great extent. Their stock markets have sympathetically self-destructed aping the stock markets of G7 economies. Their currencies have weakened to account for the likely pressure on the balance of payments.
The monetary steps that has been unleashed addressed the demand for dollars from stock market investors who were withdrawing investments from the emerging markets. The policies provided liquidity that was sucked out as the economy produced goods but those goods were not purchased due to demand destruction. The intention was to provide liquidity to push the wheels and gears of production.
But, in the face of demand destruction, how does monetary expansion help? Yes, in the first stage it is necessary to smoothen the market action and help production to continue. But, where is the fiscal stimulus to boost demand?One can only hope that the Governments have been busy preparing for the second step silently and hopefully they will announce the steps. We need effective steps. In India, unfortunately, we have no sign of such steps.
Until these steps are announced, I am not certain that we will see a major recovery in the stock markets. For the long term, I would recommend taking exposures on stocks with good OPM, high Dividend yield (compared to historical trend of the stock or industry), low price to book value and low PEs. Of course, selecting the correct industry is a problem. The negative list would include Auto, Auto Ancilliaries, Cement, Metals, Real Estate, Media, Shipping etc. I dont have a yes list but I would use the above rules to pick my stocks in various sectors.
It is still a risky game - we dont know how many more skeletons are waiting to come out and we dont know whether the recession will last one or two years. It seems policy makers are talking about a recession that is 2 years long. Buyers beware!. Dont expect major returns and keep a large stop. Happy hunting!
Monday, November 3, 2008
A good week! - The tough week approaches
Global markets recovered about 12% last week. The recovery was well expected as Indices were at multi-year lows and a bear-market rally was unavoidable.
The chances of the rally fizzling out are bright this week. I base this on the following - No major CB or Government action was reported in the Western world during the last week that could have helped to push indices up further. The US became enmeshed in the final run-up to Presidential elections, the ECB more or less threw in the towel formally (a series of rate cuts are now well-priced in), the UK is preparing to welcome the recession. However, there hasb been action in the East - China and India along with other Asian countries delivered more liquity to markets as their governments fretted about impact on growth due to the disappearence of the Western Export markets. The mother of all has been ofcourse,the cut in rates in Japan - it dropped its rate almost by half!. The Japanese are going back to their favourite item on the menu - pushing the string, nevermind that it has not helped them in the past in delivering results.
As many commentators have begun to point out, the growth engines that are still spluttering are in Asia and the burden of saving the western world is now on the Asian Central Banks and Governments. While the glee of Asian commentators is hardly masked, it appears that Asia also believes its moment has now come. But is it possible that they are mistaken in their self-belief?. Have they forgotten that their recent riches have been rub-offs (ok, they may have been well deserved), from the growth juggernaut of the Western world (it is now very easy to divide the world into East and West - Japan has stopped contributing meaningfully, to the world GDP for so many years).
Since Asian economies have become more export oriented of late, how is it possible that they could not be impacted by the disappearance of those markets? Is it possible that they continue to chug along regardless of the trouble that the locomotive is facing? Their strong currency reserves position, their healthy fiscal position and their GDP have already weakened. In such a situation is it the right thing to fritter away these strengths or is it the time to conserve these?
The damage seems strong enough to impact these economies for some years. Have markets had a chance to analyse the impact of the measurs on their ecnomies? have markets estimated when the recession in the West would end and help the Asian economies to reestablish themselves?Should caution be ignored?In the steps that Asia is taking, do we see the formation of a local bubble driven by political expediency?
Markets are likely to have a relook at the above. I expect equity markets to remain lacklustre - in any case, volumes last week have been insufficient to pronounce an end to the recent crash of stockmarkets. Weak stocks must be offloaded in this phase.
The chances of the rally fizzling out are bright this week. I base this on the following - No major CB or Government action was reported in the Western world during the last week that could have helped to push indices up further. The US became enmeshed in the final run-up to Presidential elections, the ECB more or less threw in the towel formally (a series of rate cuts are now well-priced in), the UK is preparing to welcome the recession. However, there hasb been action in the East - China and India along with other Asian countries delivered more liquity to markets as their governments fretted about impact on growth due to the disappearence of the Western Export markets. The mother of all has been ofcourse,the cut in rates in Japan - it dropped its rate almost by half!. The Japanese are going back to their favourite item on the menu - pushing the string, nevermind that it has not helped them in the past in delivering results.
As many commentators have begun to point out, the growth engines that are still spluttering are in Asia and the burden of saving the western world is now on the Asian Central Banks and Governments. While the glee of Asian commentators is hardly masked, it appears that Asia also believes its moment has now come. But is it possible that they are mistaken in their self-belief?. Have they forgotten that their recent riches have been rub-offs (ok, they may have been well deserved), from the growth juggernaut of the Western world (it is now very easy to divide the world into East and West - Japan has stopped contributing meaningfully, to the world GDP for so many years).
Since Asian economies have become more export oriented of late, how is it possible that they could not be impacted by the disappearance of those markets? Is it possible that they continue to chug along regardless of the trouble that the locomotive is facing? Their strong currency reserves position, their healthy fiscal position and their GDP have already weakened. In such a situation is it the right thing to fritter away these strengths or is it the time to conserve these?
The damage seems strong enough to impact these economies for some years. Have markets had a chance to analyse the impact of the measurs on their ecnomies? have markets estimated when the recession in the West would end and help the Asian economies to reestablish themselves?Should caution be ignored?In the steps that Asia is taking, do we see the formation of a local bubble driven by political expediency?
Markets are likely to have a relook at the above. I expect equity markets to remain lacklustre - in any case, volumes last week have been insufficient to pronounce an end to the recent crash of stockmarkets. Weak stocks must be offloaded in this phase.
Sunday, October 26, 2008
Buying time?
Whew! Stockmarkets fell 12% on an average in the last 5 days across the world. Developing Countries are locked step in step with the developed countries. This remarkable correlation suggests that the recessionary pressures are now turning global.
The fall in the Dollar against the Yen and the fall of other major currencies against the Dollar are studies in contrast. The fall of USD/JPY represents the unwinding of carry trade (at an accelerating pace if one sees the vertical fall in the currency pair) and shows that money is now getting out of global markets at an increasing pace - all that money that seems to have got into those markets in the first place, from Japan. The fall in other currencies (excl the Yen, that is) was on a simple economic rationale - the recession in US was expected for some time and the recession in Europe was a little less predicted. Eventhough the steps from UK and the Europe were comprehensive their currencies were hit by the flow of funds into the US which has been usual at such times in the past. Such flow of money seeks out US Treasuries.
A question that must be answered by those countries is - what must they do such that they could attract money, especially at such times. Look at the situation - the US economy is getting into a recession (it has caused it in the first place), yet, in such a situation the Dollar strengthens!! This is more than a dillema because the world keeps its reserves (mostly) in the Dollar. Now, as the US takes steps out of the recession, over the next few years, it does not have to worry about the cost of funding itself!
The intertwining of equitities, currencies and GDPs comes out very well in this latest episode of dominoes. Those countries that have run their economies on exports are hit by recessionary worries and falling exports hit their GDPs and of course their exchange rates. Those economies that ran current account deficits and funded those from foreign investments (into capacity creation) are anyway hit because their current accounts worsen in such situation unless imports contract. Because of capacity addition (and consequently) their imports are inelastic. Thus their currencies suffer too.
I would like to pause here to ask - is this why we are running scared here in India? Isn't the dependence on exports in India relatively small?. Don't we continue to keep our borders closed?. A few aspects must be noted here - One aspect is the growing dependence on the West in case of services (IT for example). The dependence on FIIs to keep the stock markets booming - in hundreds of stocks FIIs hold large chunks, whether individually or collectively and there sales are now driving prices to absurd levels. Promoters are dependent on FDI and PE. So many industries have thrived due to these investments. Another aspect is the wholesale dependence on FII inflows in order to build reserves. As the inflow turns into outflow we have a hit of about USD 30 billion on account of FIIs on the Reserves of the Country. The withdrawal of FDI and PE will be worth another USD 15 billion. No wonder the Rupee has fallen to 50 units against the Dollar and is likely to fall further. As FIIs suck out money and the RBI sells dollars to control the exchange rate the impact has been on the liquidity. The impact has been so grave that the large cuts in CRR and other measures taken by the RBI which are worth about Rs 150,000 crores have been completely offset by the Forex depletion and banks have said that PLR cuts are unlikely.
While GDP may fall to 7 pct or below this year and a little more next year, it is the above impacts that are confusing the minds of markets. Most stocks have reached the levels seen in the years 2002/2003 from where this bull market started - inspite of the fact that many of them are financially so much stronger and the Indian economy is still going to grow at 7 pct!
These are buying times if you believe what you read above - there is insufficient reasons for PEs to fall further or for prices to go further below book values. Market seems to be waiting for better levels to buy and the headlong crash of stocks is thus on lower volumes. Eventhough I may be wrong by some hundreds of points on BSE or some scores on the NIFTY, I would start buying now when there is so much blood on the streets.
The fall in the Dollar against the Yen and the fall of other major currencies against the Dollar are studies in contrast. The fall of USD/JPY represents the unwinding of carry trade (at an accelerating pace if one sees the vertical fall in the currency pair) and shows that money is now getting out of global markets at an increasing pace - all that money that seems to have got into those markets in the first place, from Japan. The fall in other currencies (excl the Yen, that is) was on a simple economic rationale - the recession in US was expected for some time and the recession in Europe was a little less predicted. Eventhough the steps from UK and the Europe were comprehensive their currencies were hit by the flow of funds into the US which has been usual at such times in the past. Such flow of money seeks out US Treasuries.
A question that must be answered by those countries is - what must they do such that they could attract money, especially at such times. Look at the situation - the US economy is getting into a recession (it has caused it in the first place), yet, in such a situation the Dollar strengthens!! This is more than a dillema because the world keeps its reserves (mostly) in the Dollar. Now, as the US takes steps out of the recession, over the next few years, it does not have to worry about the cost of funding itself!
The intertwining of equitities, currencies and GDPs comes out very well in this latest episode of dominoes. Those countries that have run their economies on exports are hit by recessionary worries and falling exports hit their GDPs and of course their exchange rates. Those economies that ran current account deficits and funded those from foreign investments (into capacity creation) are anyway hit because their current accounts worsen in such situation unless imports contract. Because of capacity addition (and consequently) their imports are inelastic. Thus their currencies suffer too.
I would like to pause here to ask - is this why we are running scared here in India? Isn't the dependence on exports in India relatively small?. Don't we continue to keep our borders closed?. A few aspects must be noted here - One aspect is the growing dependence on the West in case of services (IT for example). The dependence on FIIs to keep the stock markets booming - in hundreds of stocks FIIs hold large chunks, whether individually or collectively and there sales are now driving prices to absurd levels. Promoters are dependent on FDI and PE. So many industries have thrived due to these investments. Another aspect is the wholesale dependence on FII inflows in order to build reserves. As the inflow turns into outflow we have a hit of about USD 30 billion on account of FIIs on the Reserves of the Country. The withdrawal of FDI and PE will be worth another USD 15 billion. No wonder the Rupee has fallen to 50 units against the Dollar and is likely to fall further. As FIIs suck out money and the RBI sells dollars to control the exchange rate the impact has been on the liquidity. The impact has been so grave that the large cuts in CRR and other measures taken by the RBI which are worth about Rs 150,000 crores have been completely offset by the Forex depletion and banks have said that PLR cuts are unlikely.
While GDP may fall to 7 pct or below this year and a little more next year, it is the above impacts that are confusing the minds of markets. Most stocks have reached the levels seen in the years 2002/2003 from where this bull market started - inspite of the fact that many of them are financially so much stronger and the Indian economy is still going to grow at 7 pct!
These are buying times if you believe what you read above - there is insufficient reasons for PEs to fall further or for prices to go further below book values. Market seems to be waiting for better levels to buy and the headlong crash of stocks is thus on lower volumes. Eventhough I may be wrong by some hundreds of points on BSE or some scores on the NIFTY, I would start buying now when there is so much blood on the streets.
Sunday, October 19, 2008
Dow, and FTSE - bottom formation? BSE - breaking down?
An eventful week - Central Banks and Treasuries have been playing a major role in calming markets in G7. Finally, markets have begun to take wobbly steps to comfort. Capital has become king and billions are being committed to strengthen balance sheets. Banks have been forced into accepting the funds and with it will come oversight with a vengeance - politicians will be forced to have some control/review.
It wont last long for sure, since that is human nature - to refuse oversight and to demand freedom.
The reemergence of full blown business will of course take time - first step would be complete capitalisation which is inexorably linked to shareholding issues + control issues. Eventhough a full control that results from nationalisation is unlikely, oversight will be intrusive - so we have an area of conflict that will take some effort before comfort returns.
Second step would be to offer depositor (and borrower) protection more widely. A few countries have offered this and now more will be forced into this necessary trap.
Third step would be unshackle the funding and credit markets. No data has still come out to give comfot to banks so that funding can again freely flow. Central Banks will have to concentrate on this, now that the first two issues have been handled.
Lending to non-banks may unfortunately have to come later - since recession plus market disturbances are going to hit corporate profitability and credit rating.
Nevertheless, apparently a first level of support has emerged to support stock indices in G7 - the Dow and FTSE are marginally up this week. The picture for emerging economies is not that good - supports are being broken through. Which seems logical. The problem is essentially a G7 problem and of such intensity that a recession is now on the threshold. G7 countries have been most proactive too and have shown great resolve to come up with solutions. On the other hand emerging economies have felt that the waters of the tsunami would not wash onto their shores and have been blind. Now, it is clear that they will be forced to act. Korea is one shining example of the tsunami effect. The Pakistan Forex Reserves problem (which is similar to the Indian 1991 experience) suggests that some unlikely casualities are going to show up.
Meanwhile, the BSE has crashed through 10,000. However, Banking sector held up quite well. Since so many steps will come from RBI and finance ministry and since liquidity is king I am sure this sector will show good resilience for some time.
The time to accumulate on the Equity markets has begun as Warren Buffet has said. I am sanguine on this because - a)there is a coordinated approach to provide all forms of sops from all Countries b) certain markets and certain sectors have possiby been beaten unfairly and show good opportunities c) we are on the verge of entering into a low interest rate regime when funding gets cheaper and d)governments will now be forced to spend to keep away the demon of rising employment offering good demand conditions and high inflationary conditions that stock markets welcome.
It wont last long for sure, since that is human nature - to refuse oversight and to demand freedom.
The reemergence of full blown business will of course take time - first step would be complete capitalisation which is inexorably linked to shareholding issues + control issues. Eventhough a full control that results from nationalisation is unlikely, oversight will be intrusive - so we have an area of conflict that will take some effort before comfort returns.
Second step would be to offer depositor (and borrower) protection more widely. A few countries have offered this and now more will be forced into this necessary trap.
Third step would be unshackle the funding and credit markets. No data has still come out to give comfot to banks so that funding can again freely flow. Central Banks will have to concentrate on this, now that the first two issues have been handled.
Lending to non-banks may unfortunately have to come later - since recession plus market disturbances are going to hit corporate profitability and credit rating.
Nevertheless, apparently a first level of support has emerged to support stock indices in G7 - the Dow and FTSE are marginally up this week. The picture for emerging economies is not that good - supports are being broken through. Which seems logical. The problem is essentially a G7 problem and of such intensity that a recession is now on the threshold. G7 countries have been most proactive too and have shown great resolve to come up with solutions. On the other hand emerging economies have felt that the waters of the tsunami would not wash onto their shores and have been blind. Now, it is clear that they will be forced to act. Korea is one shining example of the tsunami effect. The Pakistan Forex Reserves problem (which is similar to the Indian 1991 experience) suggests that some unlikely casualities are going to show up.
Meanwhile, the BSE has crashed through 10,000. However, Banking sector held up quite well. Since so many steps will come from RBI and finance ministry and since liquidity is king I am sure this sector will show good resilience for some time.
The time to accumulate on the Equity markets has begun as Warren Buffet has said. I am sanguine on this because - a)there is a coordinated approach to provide all forms of sops from all Countries b) certain markets and certain sectors have possiby been beaten unfairly and show good opportunities c) we are on the verge of entering into a low interest rate regime when funding gets cheaper and d)governments will now be forced to spend to keep away the demon of rising employment offering good demand conditions and high inflationary conditions that stock markets welcome.
Saturday, October 11, 2008
The increasing sense of urgency - can markets survive?
During the week ending 12 October major Central Banks gave coordinated rate cuts of half percentage each. In the process, the ECB, FED had to give up their previous stances on the interest rate cuts.
The markets however, noted the significance of the move with derison - they promptly plunged deeper into fresh depths. Markets seemed confused as they were caught up in a global vicious cycle of competitive crash in equity indices, each index outdoing the other in the race to the bottom. Emerging Markets have crumpled too in this carnage. India was down 14%, Bovespa was down 20%, Thailand was down 23%. The markets in the West kept up quite well - Major indices were down atleast 20% this week.
The hand-in-hand march of indices during the last one month debunks most effectively the story put out by everyone during the last two years that the BRIC economies offered an alternative arena for investments and operated independently on their own strengths. The decoupled markets theory was developed in the last 5-6 years and sold to an "unsuspecting" west. During the carnage in the equity markets the developing countries have realised the "perils" of the globalisation and to their dismay found that markets were not decoupled - there was just a lag.
Of course, the decoupling is true definitely atleast on one account - the credit crisis that has hit the developed markets has not landed on the shores of emerging economies. Half of this is possibly due to laziness of policy makers rather than an intelligent choice of action. Equally, it is true that the caution of Central Banks has not allowed the spawning and blooming of new products and the current crisis in the emerging economies.
The impact on the emerging economies is thus on account of the risk of evaporation of export markets, the withdrawal of liquidity from their markets and the resultant impact on their GDPs. These factors are enough to bring the equity markets down. Along with that countries with insufficient balance of payments strength are hit by currency weakness and tight liquidity (and tight rates). Their Central Banks are attempting to protect the economies from these sudden impacts.
Globally, markets need to get out of the panic mode now. The G7 action is directed at that - whether collectively or individually. The UK model of capitalisation of banks as well as offering funding (along with guaranteeing market funding) is likely to be adopted in one form or other by most countries. The US is already following in that direction.
The huge growth in volume of OTC and Exchange Traded contracts amongst financial market participants covering various products was much celebrated all these years as it created employment and wealth. The large volumes is itself a result of the growth of trade, commerce, international funds flow, commodity hedging, and debt and equity funding during the last few decades. Over the years the participants have also changed - there are now a lot of retail clients and wealth management clients. Much of the activity is possibly rightly described as speculative or leveraged. Given this change, The impact of this correction on savings and GDP is possibly underestimated at this stage.
With the stock markets hitting multi-year lows and PEs dropping to single digits after the 50% fall in global indices in the last one year (and the 20% drop this week) rationality may return soon. The new week will face the market's concerns on the settlement of Lehman Contracts, the state of Morgan Stanley and the lack of fresh steps from the G7. It would be interesting to see if the market will take comfort from the increasing frequency of action from Regulators and Governments. The action is clearly directed at staving off a collapse. The measures to fight the recession will come later if markets survive.
The setting in of a recession in developed markets has been accepted more or less. But equity markets cannot give up 20% every week. This parabolic action is mostly likely signifying the bottom is now within sight.
Therefore, I would say - Hang on! We are almost there!
The markets however, noted the significance of the move with derison - they promptly plunged deeper into fresh depths. Markets seemed confused as they were caught up in a global vicious cycle of competitive crash in equity indices, each index outdoing the other in the race to the bottom. Emerging Markets have crumpled too in this carnage. India was down 14%, Bovespa was down 20%, Thailand was down 23%. The markets in the West kept up quite well - Major indices were down atleast 20% this week.
The hand-in-hand march of indices during the last one month debunks most effectively the story put out by everyone during the last two years that the BRIC economies offered an alternative arena for investments and operated independently on their own strengths. The decoupled markets theory was developed in the last 5-6 years and sold to an "unsuspecting" west. During the carnage in the equity markets the developing countries have realised the "perils" of the globalisation and to their dismay found that markets were not decoupled - there was just a lag.
Of course, the decoupling is true definitely atleast on one account - the credit crisis that has hit the developed markets has not landed on the shores of emerging economies. Half of this is possibly due to laziness of policy makers rather than an intelligent choice of action. Equally, it is true that the caution of Central Banks has not allowed the spawning and blooming of new products and the current crisis in the emerging economies.
The impact on the emerging economies is thus on account of the risk of evaporation of export markets, the withdrawal of liquidity from their markets and the resultant impact on their GDPs. These factors are enough to bring the equity markets down. Along with that countries with insufficient balance of payments strength are hit by currency weakness and tight liquidity (and tight rates). Their Central Banks are attempting to protect the economies from these sudden impacts.
Globally, markets need to get out of the panic mode now. The G7 action is directed at that - whether collectively or individually. The UK model of capitalisation of banks as well as offering funding (along with guaranteeing market funding) is likely to be adopted in one form or other by most countries. The US is already following in that direction.
The huge growth in volume of OTC and Exchange Traded contracts amongst financial market participants covering various products was much celebrated all these years as it created employment and wealth. The large volumes is itself a result of the growth of trade, commerce, international funds flow, commodity hedging, and debt and equity funding during the last few decades. Over the years the participants have also changed - there are now a lot of retail clients and wealth management clients. Much of the activity is possibly rightly described as speculative or leveraged. Given this change, The impact of this correction on savings and GDP is possibly underestimated at this stage.
With the stock markets hitting multi-year lows and PEs dropping to single digits after the 50% fall in global indices in the last one year (and the 20% drop this week) rationality may return soon. The new week will face the market's concerns on the settlement of Lehman Contracts, the state of Morgan Stanley and the lack of fresh steps from the G7. It would be interesting to see if the market will take comfort from the increasing frequency of action from Regulators and Governments. The action is clearly directed at staving off a collapse. The measures to fight the recession will come later if markets survive.
The setting in of a recession in developed markets has been accepted more or less. But equity markets cannot give up 20% every week. This parabolic action is mostly likely signifying the bottom is now within sight.
Therefore, I would say - Hang on! We are almost there!
Sunday, October 5, 2008
End of Bearish Road? - A short-term recovery in sight?
Over this weekend confusion has set in on the rescue package that was "finalised" last week regarding the troubled Hypo Real Estate Bank. Europe is now desperately trying to find a strong fix to the problems arising in its zone. In the US the TARP is likely to roll out in the next 7-10 days after its successful legislation.
The accomplishment of TARP passage represents a turnaround of the legislative opinion and a willingness to challenge public opinion. But, the true size of the problem is now becoming clear to all. Banks are panicking and have hoarded liquidity (whatever is with them) and have been borrowing/lending for overnight tenor at atrocious rates.
The steps taken by various Central Banks have not yet addressed the fear factor of banks. Already Central Banks and their Governments have forcefully merged weak entities with stronger entities, guaranteed liabilities of banks, worked on bail-out funds and considered capitalisation of banks. Serious thought is being directed at giving up the Mark-to-Market accounting.
Out of all, the last one is the most simple to achieve. That is being mistaken for effectiveness. In the current panic conditions, when markets have all but closed down, prices are not representative of the unwind values or cash value of assets. The volume available for a price is very low and hence such prices are not representative of the liquidation value of assets of any respectable size.
Enough reasons exist for giving up the MTM accounting, but this is turning logic on its head - wasn't MTM accounting introduced in the first place such that Lenders could make their lending decisions with full information to determine the liquidation value of a firm? If liquidation value is not available any longer then are lenders to assume atleast full liquidation value of assets? Everyone knows what is happening to asset values now. So, on what logic would MTM accounting be removed? Would all banks now carry a guarantee from Central Banks/Treasuries that they would repay borrowings on time?
It is unclear to me whether lenders would prefer to lend blindly to borrowers after the withdrawal of MTM accounting? Would this lead to freezing of the system or greasing of the system? And when the MTM accounting is reintroduced would banks show up stronger or weaker?
The desperation to withdraw MTM accounting represents the extent of the problem. Central Banks will now have to play an increasingly direct role to ensure that liquidity returns to the markets. A coordinated approach across continents is still lacking. It is quite clear that the approach would have to cover capitalisation (including a debt/equity swap), funding, lowering capital ratios, putting weaker banks under special liquidity oversight. It appears that the withdrawal of MTM accounting is one esential ingredient in the solution to improve capital of banks.
It is quite clear that a complex solution would have to emerge.
Meanwhile, evidence of recession is emerging across the US and Europe. Banks are hibernating and unless the markets restart and credit flows again, a deep rooted recession will set in across countries. Stock markets are collapsing and the Dollar is holding on as more countries begin to be hit. The strength of Dollar is the hope that the US will have a short recession (as compared to other countries and in keeping with the record of last few decades) whereas other countries will flounder and will take longer to get out of recession. Since the problem is inexorably linked to the US and hence the Dollar, funding of those losses would have to be in Dollars and hence the big demand for the currency has led to the destruction of the interest rate parity across so many curreny pairs.
Indian Markets -
The NIFTY has rested at 3818.30 on 3 October 2008 very close to the low of 3816.70 seen on 16 July 2008. The ongoing crisis of confidence is likely to bring the NIFTY to 3626.85 last seen on 7 March 2007. I think this is where support will potentially emerge for the short to medium term. However, since negative news for the Indian economy is starting to filter in only in the last few months, I would not be surprised if the Index falls towards the 2550-2600 zone. That zone may be reached over some months if a deep recession sets in. Invariably, to meet that target, it is necessary that demand destruction happens in India over the next 3-6 months coinciding with a furthering of the pain and correction overseas.
The Rupee is also now reaching a potential support zone. It may be noted that the level of 47.40-47.60 is a potential zone of reversal, never mind the worsening external account. At this stage RBI should be expected to use its reserves to protect the exchange rate of Rupee. It will also be necessary to introduce other steps to control the depreciation of the Rupee. How about opening of more sectors for FDI? or increase in the limits for FDI in the various sectors?.
Interest Rates have also reached a possible peak in India. Here, while the positives have been very well noted by all I wonder if possible risks have been noted too. What about risks such as withdrawal of liquidity via the FII route? Would RBI provide liquidity through a CRR cut or a SLR cut? I don't think so. What about potential for larger issuance of securities by the Central and State Governments to fund deficits in revenues (due to the weak economy)? Nevertheless rates have possibly very little upside left.
I wonder if a recovery is at hand? See you next week!
The accomplishment of TARP passage represents a turnaround of the legislative opinion and a willingness to challenge public opinion. But, the true size of the problem is now becoming clear to all. Banks are panicking and have hoarded liquidity (whatever is with them) and have been borrowing/lending for overnight tenor at atrocious rates.
The steps taken by various Central Banks have not yet addressed the fear factor of banks. Already Central Banks and their Governments have forcefully merged weak entities with stronger entities, guaranteed liabilities of banks, worked on bail-out funds and considered capitalisation of banks. Serious thought is being directed at giving up the Mark-to-Market accounting.
Out of all, the last one is the most simple to achieve. That is being mistaken for effectiveness. In the current panic conditions, when markets have all but closed down, prices are not representative of the unwind values or cash value of assets. The volume available for a price is very low and hence such prices are not representative of the liquidation value of assets of any respectable size.
Enough reasons exist for giving up the MTM accounting, but this is turning logic on its head - wasn't MTM accounting introduced in the first place such that Lenders could make their lending decisions with full information to determine the liquidation value of a firm? If liquidation value is not available any longer then are lenders to assume atleast full liquidation value of assets? Everyone knows what is happening to asset values now. So, on what logic would MTM accounting be removed? Would all banks now carry a guarantee from Central Banks/Treasuries that they would repay borrowings on time?
It is unclear to me whether lenders would prefer to lend blindly to borrowers after the withdrawal of MTM accounting? Would this lead to freezing of the system or greasing of the system? And when the MTM accounting is reintroduced would banks show up stronger or weaker?
The desperation to withdraw MTM accounting represents the extent of the problem. Central Banks will now have to play an increasingly direct role to ensure that liquidity returns to the markets. A coordinated approach across continents is still lacking. It is quite clear that the approach would have to cover capitalisation (including a debt/equity swap), funding, lowering capital ratios, putting weaker banks under special liquidity oversight. It appears that the withdrawal of MTM accounting is one esential ingredient in the solution to improve capital of banks.
It is quite clear that a complex solution would have to emerge.
Meanwhile, evidence of recession is emerging across the US and Europe. Banks are hibernating and unless the markets restart and credit flows again, a deep rooted recession will set in across countries. Stock markets are collapsing and the Dollar is holding on as more countries begin to be hit. The strength of Dollar is the hope that the US will have a short recession (as compared to other countries and in keeping with the record of last few decades) whereas other countries will flounder and will take longer to get out of recession. Since the problem is inexorably linked to the US and hence the Dollar, funding of those losses would have to be in Dollars and hence the big demand for the currency has led to the destruction of the interest rate parity across so many curreny pairs.
Indian Markets -
The NIFTY has rested at 3818.30 on 3 October 2008 very close to the low of 3816.70 seen on 16 July 2008. The ongoing crisis of confidence is likely to bring the NIFTY to 3626.85 last seen on 7 March 2007. I think this is where support will potentially emerge for the short to medium term. However, since negative news for the Indian economy is starting to filter in only in the last few months, I would not be surprised if the Index falls towards the 2550-2600 zone. That zone may be reached over some months if a deep recession sets in. Invariably, to meet that target, it is necessary that demand destruction happens in India over the next 3-6 months coinciding with a furthering of the pain and correction overseas.
The Rupee is also now reaching a potential support zone. It may be noted that the level of 47.40-47.60 is a potential zone of reversal, never mind the worsening external account. At this stage RBI should be expected to use its reserves to protect the exchange rate of Rupee. It will also be necessary to introduce other steps to control the depreciation of the Rupee. How about opening of more sectors for FDI? or increase in the limits for FDI in the various sectors?.
Interest Rates have also reached a possible peak in India. Here, while the positives have been very well noted by all I wonder if possible risks have been noted too. What about risks such as withdrawal of liquidity via the FII route? Would RBI provide liquidity through a CRR cut or a SLR cut? I don't think so. What about potential for larger issuance of securities by the Central and State Governments to fund deficits in revenues (due to the weak economy)? Nevertheless rates have possibly very little upside left.
I wonder if a recovery is at hand? See you next week!
Sunday, September 28, 2008
Bear Market seen
So, we are adding more names to the doomed institutions list - B&B, Fortis(?), Wachovia(?). Apparently, everyone is hurtling downwards. How quickly things change? Britain is on a nationalisation route and the US is quietly getting ready to buy up Banks and FIs.
And apparently markets are picking up venerable names, one after the other and pummelling them into mergers, sell-downs and in the process challenging Regulators and Governments to come to the rescue of their institutions - the Dutch and Belgian Governments' joint plan for Fortis is remarkable in this context as is Wachovia's desperation to save itself from the effect of distressed assets.
Undoubtedly, many assets will turn distressed if credit spreads widen. Assets will lose value as fresh prices are discovered by banks forced to sell down. The Paulson plan is aimed at preventing this kind of a rout. As everyone rushes to the exit the price to exit increases and by legislating to buy atleast some (toxic) assets the US is seeking to build a floor and strengthen the foundation so that hopefully valuation of assets improves.
But, if Wachovia has USD 100 billion plus of distressed assets what about the system? How will the situation improve and how will recovery set in? Clearly, this requires co-ordinated Government + Central Bank actions. But, will one Paulson plan suffice? It is a plan that will unravel in instalments. What if we have a couple of fresh cases this week? The stop to the rout can come from a large size plan or by way of effective common plans driven by the might of several sovereigns.
Markets seem to be testing Sovereigns and Central Banks - when will there be a joint intevention and what forms would such intervention take?
Meanwhile, more and more countries in the west are discovering state managed "capitalism". In India and in certain other countries this model has been in existence. The West will now have to learn to run its economies where Government Owned ("Sponsored") Institutions co-existing with Private Institutions. Two outcomes would be keenly observed from here - how successful would such co-existence be, and how soon would the Government be allowed (forced?) to take its profit from such investments.
Also meanwhile, Stocks in India have performed as I expected. We had a good 6 pct plus fall on NIFTY and SENSEX. More mayhem should be expected though initially markets are expected to open stronger on Monday due to the passage of the Paulson package this weekend. But, markets should quickly move to retest the recent lows of around 12,500. I am sanguine that the sensex should hit about 10,500 in one month's time.
Buying may come in once the overseas markets stablise. Indian economy is unlikely to offer great GDP numbers until 2009-10. Many sectors such as Realty, FMCG, Infrastructure etc have to give up their high PEs. I expect a bottom to form when PE of the broad market falls to 14 or lower. Banking may recover the fastest as PEs are already very low.
Two worries loom over the Indian markets/economy - the Rupee will come under increasing pressure if global markets do not recover (and when rating agencies announce any downgrade) or if global institutions do not strengthen. There are still enough negatives in the pipeline globally - unemployment, recession, inflation etc. As Indian economy weakens in the near future, inflow of FII money will be delayed. Inflow of FDI is also likely to be slow while PEs would definitely capitulate. Remember PEs have a short gestation period and many of them have been burnt. Should forex inflows suffer as I expect, controlling the Rupee and the inflation would be challenges. The bear cycle which we entered about 2 quarters ago will have about 4 quarters to go further if the above plays out as I expect.
Stay safe! See you next week!
And apparently markets are picking up venerable names, one after the other and pummelling them into mergers, sell-downs and in the process challenging Regulators and Governments to come to the rescue of their institutions - the Dutch and Belgian Governments' joint plan for Fortis is remarkable in this context as is Wachovia's desperation to save itself from the effect of distressed assets.
Undoubtedly, many assets will turn distressed if credit spreads widen. Assets will lose value as fresh prices are discovered by banks forced to sell down. The Paulson plan is aimed at preventing this kind of a rout. As everyone rushes to the exit the price to exit increases and by legislating to buy atleast some (toxic) assets the US is seeking to build a floor and strengthen the foundation so that hopefully valuation of assets improves.
But, if Wachovia has USD 100 billion plus of distressed assets what about the system? How will the situation improve and how will recovery set in? Clearly, this requires co-ordinated Government + Central Bank actions. But, will one Paulson plan suffice? It is a plan that will unravel in instalments. What if we have a couple of fresh cases this week? The stop to the rout can come from a large size plan or by way of effective common plans driven by the might of several sovereigns.
Markets seem to be testing Sovereigns and Central Banks - when will there be a joint intevention and what forms would such intervention take?
Meanwhile, more and more countries in the west are discovering state managed "capitalism". In India and in certain other countries this model has been in existence. The West will now have to learn to run its economies where Government Owned ("Sponsored") Institutions co-existing with Private Institutions. Two outcomes would be keenly observed from here - how successful would such co-existence be, and how soon would the Government be allowed (forced?) to take its profit from such investments.
Also meanwhile, Stocks in India have performed as I expected. We had a good 6 pct plus fall on NIFTY and SENSEX. More mayhem should be expected though initially markets are expected to open stronger on Monday due to the passage of the Paulson package this weekend. But, markets should quickly move to retest the recent lows of around 12,500. I am sanguine that the sensex should hit about 10,500 in one month's time.
Buying may come in once the overseas markets stablise. Indian economy is unlikely to offer great GDP numbers until 2009-10. Many sectors such as Realty, FMCG, Infrastructure etc have to give up their high PEs. I expect a bottom to form when PE of the broad market falls to 14 or lower. Banking may recover the fastest as PEs are already very low.
Two worries loom over the Indian markets/economy - the Rupee will come under increasing pressure if global markets do not recover (and when rating agencies announce any downgrade) or if global institutions do not strengthen. There are still enough negatives in the pipeline globally - unemployment, recession, inflation etc. As Indian economy weakens in the near future, inflow of FII money will be delayed. Inflow of FDI is also likely to be slow while PEs would definitely capitulate. Remember PEs have a short gestation period and many of them have been burnt. Should forex inflows suffer as I expect, controlling the Rupee and the inflation would be challenges. The bear cycle which we entered about 2 quarters ago will have about 4 quarters to go further if the above plays out as I expect.
Stay safe! See you next week!
Sunday, September 21, 2008
A Roller Coaster Week
The fall of Investment Banking icon Lehman was potrayed as an unavoidable event - afterall Capitalism depended on efficiency (or was it, that it achieved efficiency?). So weak participants had to fail. But the chain reaction to that event was possibly poorly expected. The events over the last one year plus, when so many banks/institutions failed, have led to markets getting increasingly nervours. Banks had not been trusting each other and markets had become shallow. Remember that the top Central Bankers have been providing liquidity against all forms of collateral and cajoling banks to keep the money markets well oiled. The fall of Lehman suggested things could worsen and more would succumb in the black hole. Afterall, if everyone was in the same business and carried the same stocks how long could one hold on when prices were falling. Markets had smelt blood and they began looking for more - as stocks were short sold and CDS rates pushed up by panicking protection buyers they threatened the institutions. No institution was now safe. This is the sort of panic reaction that brought out rescue calls - Paulson and Bernanke donned on "socialist" hats and quickly nationalised AIG (80% control). Across the world short selling was severely controlled - so we have multi-year single day rallies in stocks at the weekend. Whew! - What a roller coaster. Suddenly we have bullish calls on stock markets! Before, we begin to invest in stock markets let us stop to think -
The steps were necessary regardless of whether it was capitalism or socialism that ruled the US and the rest of the West. Remember Russia closed down its markets for days. When panic strikes, Regulators and governments have no choice of isms. They have to act.
The funding of the US banks by the Treasury will surely bring back relief for some time. But, in that time it will rear a few doubts such as, what sort of regulation or control does the US have, how strong/weak are the banks, and arising from these and other concerns, markets will ask again - should they short the dollar? Surely, this thought cannot be regulated away! The pullback of the markets is exactly a relief reaction-it will not alter anything. Of course, I do not ignore the large positive impact that has been so carefully co-ordinated into the markets will pay positive dividends. But, it may not give us the insurance against a repeat of carnage. Why?
Sovereign funds and others will be looking around for stronger currencies (i.e., economies). Here they will find very few options and that is likely to come to the rescue of the dollar for some time. The European and Japanese economies do not excite anyone. In any case, as the latest episode has proved once more, the US is quick on its feet. Cynics may say the US policy makers cannot afford to be lazy and lose the attraction of the dollar. But, the US will take time to get its economy up again and more failures (and rate cuts) cannot be wished away. Since, EUR and GBP have no strong economic strength to back them up, currencies in Asia may beckon.
Asian economies seem to be holding out well so far. Have their higher growth rates cushioned them or is it their closed economies? Meanwhile, debate rages - Asia has succeeded because it has been careful in not letting their markets become gambling dens, the Regulators have been more careful in deregulating and the rest. They will self-congratulate themselves on their better management (is it better luck?) and as their economies seem destined to generate stronger growth their relative position should become stronger. But, what happens to their currencies? Don't forget that they basked in the big rush of dollars as the Investment Bankers set up offices and desperately tried to invest in their countries? With capital flows likely to come off how long before the party poops in Asia as well? If their Central Banks don't buy the dollars what about the reserves and the liquidity releases that kept rates low? A small club of Asian economies that have the luxury of large current account surpluses seem the ones whose currencies will remain strong. The currencies of those with weak current accounts should remain weak as Capital should remain scarce for some time. And, if foreign capital is not chasing the stock markets of Asia, what about their PE ratios?
So, would you buy Asian Stocks? I would not until PEs fall further.
See you next week!
The steps were necessary regardless of whether it was capitalism or socialism that ruled the US and the rest of the West. Remember Russia closed down its markets for days. When panic strikes, Regulators and governments have no choice of isms. They have to act.
The funding of the US banks by the Treasury will surely bring back relief for some time. But, in that time it will rear a few doubts such as, what sort of regulation or control does the US have, how strong/weak are the banks, and arising from these and other concerns, markets will ask again - should they short the dollar? Surely, this thought cannot be regulated away! The pullback of the markets is exactly a relief reaction-it will not alter anything. Of course, I do not ignore the large positive impact that has been so carefully co-ordinated into the markets will pay positive dividends. But, it may not give us the insurance against a repeat of carnage. Why?
Sovereign funds and others will be looking around for stronger currencies (i.e., economies). Here they will find very few options and that is likely to come to the rescue of the dollar for some time. The European and Japanese economies do not excite anyone. In any case, as the latest episode has proved once more, the US is quick on its feet. Cynics may say the US policy makers cannot afford to be lazy and lose the attraction of the dollar. But, the US will take time to get its economy up again and more failures (and rate cuts) cannot be wished away. Since, EUR and GBP have no strong economic strength to back them up, currencies in Asia may beckon.
Asian economies seem to be holding out well so far. Have their higher growth rates cushioned them or is it their closed economies? Meanwhile, debate rages - Asia has succeeded because it has been careful in not letting their markets become gambling dens, the Regulators have been more careful in deregulating and the rest. They will self-congratulate themselves on their better management (is it better luck?) and as their economies seem destined to generate stronger growth their relative position should become stronger. But, what happens to their currencies? Don't forget that they basked in the big rush of dollars as the Investment Bankers set up offices and desperately tried to invest in their countries? With capital flows likely to come off how long before the party poops in Asia as well? If their Central Banks don't buy the dollars what about the reserves and the liquidity releases that kept rates low? A small club of Asian economies that have the luxury of large current account surpluses seem the ones whose currencies will remain strong. The currencies of those with weak current accounts should remain weak as Capital should remain scarce for some time. And, if foreign capital is not chasing the stock markets of Asia, what about their PE ratios?
So, would you buy Asian Stocks? I would not until PEs fall further.
See you next week!
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