A blip in the uptrend....or the harbinger of the real crash?

Global equity markets have been in a tailspin over the past week, led by the developed markets and the emerging markets following suit. The seemingly complacent view of the world economy having put the recession behind has been shaken, and how!! Question marks have begun to emerge on the sustainability of the economic recovery, especially given the fact some central banks across the globe have now started thinking of measures of withdrawing the stimuli infused in 2008.

And that is precisely where the problem lies. The seemingly strong "recovery" in financial markets from March 2009 to present has been fuelled by a gush of liquidity from central banks. The concerted actions by global central banks helped avert a total collapse in the global economy, but might have laid the foundation for the next shake up. Noted investment stalwarts like George Soros and economists like Nouriel Roubini dubbed " Dr Doom" for his prediction of the global crisis of 2007 have said global financial markets have run up too much too soon. What is remarkable about the rally is almost all asset classes most notably commodities, equities and foreign exchange have all run up at the same time. Seldom is this kind of run sustainable.

News on the economic front though better than earlier, is far from making a person ga-ga. Authorities in the US reportedly seized 9 banks in a single day on October 31st, the most since the crisis began in 2007. The US economic system still seems to be struggling if macro numbers are anything to go by. Unemployment remains high, the housing market still suffers from a huge inventory hangover, foreclosures remain at stratospherically high levels. In fact it is now being said the next wave of foreclosures could be in prime loans, a scenario likely to fan out in 2010.

What next for the stock markets now? Technical analysis already suggests this is just the beginning of a major fall, not the major fall. I would not be surprised if most of the stock markets retrace a major portion of the gains made over the past six months. Stock markets like most other asset classes now look like a sell on rallies rather than a buy on dips. The US Dollar, which has been beaten down massively while most asset classes have rallied gives a feeling of deja vu as in January 2008, a big rally could be underway in the greenback. Though the rally might have just begun, the next leg of the move is likely to come as Dollar bears scramble to cover their shorts.

We are at interesting crossroads, remains to be seen how markets behave from here. For me personally, its the defensive approach. Sell stocks move into cash and wait for better entry levels. Though i guess entry levels are about 6 months away atleast, i continue to watch market movements with a great deal of intrigue.

Are the good times back again?

Its been such a long time that i updated my blog....but the numerous twists taken by financial markets especially stocks have held me in intrigue, like almost all of my brethren analysts. The gloomy and dull period that was 2008 seems like a distant memory now, saying it has faded into oblivion would be an exaggeration.

The performance of global equity markets over the past 6 months since March 6th to be precise, has been all but astonishing, bewildering, astounding (might run out of adjectives here!) No wonder us analysts are in a conundrum whether the recovery in equity markets is a precursor of a recovery in the real economy? This is because stocks trade on expectations while actual grass root developments take place subsequently.

In my view, the present rally can be attributed to massive amounts of liquidity pumped into the global economy by several central banks acting in concert. True, the central banks succeeded in stemming the evident rot in the system during 2008 or did they? Another central theme behind the present rally has been a weakening US Dollar, de facto the world's reserve currency. Is a weaker currency bad for a country?? Not necessarily, a weaker US Dollar helped finance the US trade deficit and also helped lower the deficit by making imports cheaper.

The real economy remains far from a recovery, which can be highlighted by economic data. Unquestionably one of the most significant indicators is the employment number. It seems staggering that the US stock markets have risen about 60% since March '09 even as unemployment has risen to 9.8% the highest since 1983 while employers shed 263000 jobs in September.

Reports of banks increasing mortgage durations to dissuade delinquencies are distorting the real picture. Mortgages still remain a ticking time bomb, commercial real estate and credit cards could be two potential problem areas going ahead. It also remains to be seen whether a withdrawal of fiscal stimuli by central banks impacts market sentiment. A statement by Fed Chairman Ben Bernanke of tightening when the economy recovers, spooked markets particularly commodities.

And what about the Dollar? The sheer unanimity in expecting a weaker US Dollar does not augur well at all. The last time such a thing had happened was in Q4 2007, after which the Dollar rallied sharply through most of 2008. Are we in for an encore...time will tell. In the meanwhile, like most investors i am taking advantage of the opportunity markets have given all of us to smile. Whether the smile remains or turns back into a frown is uncertain... i rather hope not!

Has the sun finally risen on the global economy?

Its obvious this question must have arisen in a lot of investors minds, especially considering the way most asset class prices have rallied over the past 3-6 months. Is the sub prime crisis and its spillover effects well and truly behind us? I do not believe that's the case, atleast not yet.

To put things in perspective, its the fact that things are getting "terrible" from a "disastrous" state 9-12 months ago. Which means there still exists scope for pain ahead in global financial markets. It also needs to be remembered, the huge gush of liquidity brought in by several central banks might already be setting the stage for the next bubble. However, we could be a few years away yet from the formation of a new bubble.

The problem areas still remain strewn over different geographies and asset classes. In terms of geographies, the UK and Eastern Europe come to mind. Debt and mortgage levels remain high across both regions, Eastern Europe had been in particular focus due to problems with the Latvian economy. The US housing market still faces high inventory levels notwithstanding the recent positive numbers. Currencies also seem to indicate low confidence in the present rally, which is illustrated by the lack of upside momentum against the US Dollar.

Another important charachteristic of this rally has been this has been driven by "expectations". What happens should these expectations be disappointed? It is notable to state almost all asset classes i.e stocks, bonds, currencies, commodities have all rallied at the same time. Such rallies do tend to shake the belief of the most seasoned investors who have a defensive approach, let alone a guy like me who is still on the learning curve.

Adopting contrarian positions in such times is likely to be extremely rewarding, albeit there could be some amount of pain in the short term. Examples could be taking profit in equities and buying the US Dollar. Its almost a consensus view that the US Dollar is likely to weaken, even a slight strengthening of the US Dollar in the event of any new crisis is likely to send the cat amongst the pigeons. Though its difficult to pinpoint what the new crisis might be, a crisis of confidence in government debt (of Eastern European countries for e.g.) or even a currency crisis does not seem far fetched. Noted investor Jim Rogers believes the world is likely to see a currency crisis sometime in the near future.

So what would i be doing? Well, all a small investor like me can do is take profits on equities, wait and watch. The dawn might be here, but we are some way away from the sunrise as yet!

Watta damp squib!!!

That was the reaction i had after listening to the Finance Minister's budget speech.Even as the speech was only halfway through, i had the feeling markets would sell off. And even at this moment, the benchmark indices have shown a big thumbs down to the budget the Nifty down 209 points and the BSE Sensex down 700 points.

The budget was a reality check for investors who thought big bang reforms were almost a certainty, given the thumping majority for the UPA in the general elections. What caused the sell off?? The primary reason in my view is a lack of action on two major areas 1) Infrastructure spending 2) Disinvestment. It was expected infrastructure spending would be upped significantly, though there was an announcement of increased spending it did not have the tone markets were expecting. Disinvestment was by far the biggest disappointment. The fiscal deficit is also expected to be higher than was anticipated by the markets. Foreign direct investment and the lack of clarity on the fuel pricing mechanism were also significant negatives.

I am not surprised if we see the Indian market cracking further under the weight of selling pressure, especially from FII's. What was touted as a dream budget, turned out to be a nightmare on account of inaction, well almost!! Needless to say investors who were shouting from roof tops on the renewed potential in India are likely to have a relook at their stance. Clearly the market had run ahead of itself in amassing expectations, there was a risk even a small deviation from expectations would result in a sharp knee jerk reaction. And this seems to have materialized. It needs to be remembered the Indian story is still intact, the short term weakness is a readjustment to reality.

What next from here? I expect the Indian market to possibly undergo a re-rating, even slight de-rating in the short term as brokerages review their "outrageously" bullish outlooks in the post budget scenario. Banks and infrastructure are two sectors which look vulnerable to me in the short term, especially after having witnessed sharp run ups over the past few months.

Global markets pose another significant risk to the market performance going ahead. True, the global risk always persisted somehow the domestic market performance was somewhat oblivious to international markets given a strong emphasis on India being a "domestic demand" driven economy. This hypothesis will surely be tested over the next 9-12 months. Meanwhile, the best thing to do for now is to wait and watch how the market behaves after the initial reaction which might last about 4-5 days.

Are the Developing markets the saviours for the global economy?

The developing markets were considered the poor cousins of the developed economies. However with the passage of time it was realized these countries had the potential to provide a fresh impetus to economic growth in world markets. The allure of these countries was further enhanced when economists from Goldman Sachs coined the term BRICS (Brazil, Russia, India and China).These countries had all the right ingredients-huge populations, rising income levels and low penetration of necessary services like banking which made them attractive investment avenues.

The potential of these markets was further magnified when noted fund managers like Jim Rogers and Mark Mobius, the "Indiana Jones" of the financial markets stressed the return potential offered by these markets to foreign investors. The emerging markets have well and truly picked up the baton of economic growth from the developed world and gone on from strength to strength. The pace of growth in these economies has been stunning, using an adjective like "bewildering" to also describe the pace of economic growth is not entirely misplaced.

A recent report released by the World Bank confirmed what most people in the investment fraternity have believed for long. World Bank estimates show a big dichotomy in growth expectations, which can be seen by the following table:








Its no wonder the top performing equity markets globally are the emerging markets. This can be attributed to expectations of these countries filling in for slumping demand from the developed world and helping the global economy extricate itself from possibly the sharpest slump in economic activity since World War II. The following table shows year to date performance of equity markets across different regions:














Source: Bloomberg, as of June 25 2009


However it is very easy to get carried away and extrapolate the growth prospects for these economies. One needs to be a bit more circumspect when evaluating returns potential. The BRIC countries have had their share of problems for example India grapples with a high fiscal deficit and is vulnerable to any spike in commodity prices, most notably crude oil. Uncertainty over the monsoon could slightly dampen expectations, it remains to be seen how the situation evolves over the next month or so. The latest move to bailout Air India could further widen the fiscal deficit. India can ill afford largesse like these.

The emerging markets hold tremendous growth potential and should continue to provide traction to the wheels of the global economy in the future.

Is it a new dawn for the global economy?

Well this question has been one which has the analysts community split right down the middle. I belong to the camp which believes there are still lower lows waiting to be hit across the spectrum of asset classes, be it stocks or commodities. The recent rally has made the sceptics camp look dumb, as a gush of liquidity led to a rocketting of prices across asset classes.

Are we really on the cusp of a rekindling of the growth story in the global economy? I think its too early to tow that line of thought. Albeit its emergin market economies have witnessed stellar runs, supported by enhanced liquidity and expectations of economies like India and China being the growth engines for the global economy. The fact that developed world economies like the US and the Euro zone are still plauged with problems tends to get overlooked. The US still faces the problems of a huge deficit, while the Euro zone is likely to encounter stress from problems emanating from its banking system.

Clearly, the basis for the present rally across asset classes has been injections of massive liquidity. Several global economies have witnessed stimuli from governments in one form or the other, which has helped arrest the decay in economic activity. The sustainability of the present rally remains questionable.

True the emerging markets have been at the forefront of this rally, but they still have their own vulnerabilities. Lets take the case of China and India. Though the dragon has well and truly stirred, China remains an export oriented economy. A significant share of its export trade is with the US, a cooling off in demand could lead to a slowdown in the chinese financial system. The Indian case is interesting, as the allure of the country has increased manifold after the thumping win for the Congress led alliance in the recent general elections. Its very easy to extrapolate expectations and re-rate asset classes. The Indian story looks to have seen a sustainably positive turn, however the rating of markets has been devoid of sanity as too much has been discounted too soon.

In my view, we could be on the verge of shocks. Markets have a tendency to surprise on the opposite side, much to the chagrin of investors. An example here can be the US Dollar. The whole world had a unanimously bearish view at the beginning of 2008, and what did the greenback do? It rose sharply through the year. Are we in for a dejavu? A couple of other indicators point to this too. Risk aversion which is represented by the VIX index looks to be in the process of forming a bottom. A sustained rise in the VIX is dangerous for stocks and commodities due to an inverse correlation. The Japanese Yen, another safe haven instrument in turbulent times could appreciate further and retest the low set at 86-87. The Dow Jones Index has been unable to convincingly breach key resistance levels, which suggests investors are cautious.

Where do we go from here? I believe stocks and commodities could retest their lows and even go lower from there. To cite an example of Crude Oil, i believe crude oil should test between USD 76-78 and then start falling. Purely on a technical basis, a new low could be in the offing. Or would it? Only time will tell....

Has the storm passed global markets?

It wouldnt be a surprise to think on these lines, as global financial markets especially Equities have settled in a range.Is this the lull after a storm or a lull before the onset of the next upheaval? I would argue its somewhere between the two. Financial markets seem to have priced in a lot of bad news already, which is a slightly comforting fact for investors. The not so comforting fact is, we could have the next storms beginning to take shape already.

I would equate the present climate in global markets to the US hurricane season of 2005, which was the most active hurricane season on record when 15 hurricanes were recorded. Where i draw a resemblance is, global markets have been hit by bad news at regular intervals. No sooner one crisis eases, another seems to creep up. First it was the subprime crisis, then it was the credit crisis. Even as the world still recuperates from these twin blows, even bigger problems could be in the pipeline.

The news of a $50 bn fraud by a hedge fund run by the former chairman of the Nasdaq Bernard L Madoff is a huge setback for investor confidence in hedge funds. The hedge fund industry has been on course to post the worst year on record, as they have been hit by redemption pressures as investors sought to reduce risk. This news could potentially become a huge problem, how it affects markets remains to be seen.

Another potential problem area is commercial real estate. An article on the Dow Jones Newswires said data from Standard & Poor's shows nine large banks hold about $121.1 bn in commercial real estate loans. These loans have to be marked to market. The three biggest holders are Citigroup, Merrill Lynch and Barclays, which each hold more than $ 20 bn of related investments. A next wave of write off could be around the corner.

Credit cards could be in line as well. Rising unemployment is bound to hamper the repayment capacity of borrowers and in turn create headaches for the lenders. An article in the Wall Street Journal quoting te Nilson report, a newsletter that follows the industry stated JP Morgan Chase, Bank of America and Citigroup had nearly 60% of the $ 724.44 bn in outstanding loans at the 10 biggest card issuers in the US as of June 30. One need not be a rocket scientist to do the arithmetic. Writeoffs on credit cards could be huge....thats not an understatement by any stretch of imagination.

Well, the markets seem hell bent on giving us analysts a tough time even in 2009. For now, i await the onset of a much needed break at the year end. I hope 2009 will not be as bad as 2008, but all i can do is hope, wait and watch.