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!

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!