By nature, I am a pretty optimistic person and that has meant that in the markets, I am more willing to take a bullish bet than a bearish one. In fact, if I were to go back to all my postings I have made here since the start of the group, the tone is one of bullish with markets ready to be bought or the time just about to come. In that sense, I think this will be a bearish post written after a real long time.
My last long post I wrote here was about how India story was not dead and one should buy at current levels and add if markets drop down to 5100 or 4600. I wrote that on April 16 and in the coming weeks, markets rose by over 10%. But with bearishness enveloping much of the world, we are now back to where we started from.
But during the time in between, I have had a major change of heart. For the first time in my trading career, I sold out my portfolio completely (save for those physical shares for whom there are no bidders 🙂 ). The reason for the action was that One, I did not seem to have the time or the inclination to follow up on my portfolio and the stocks to be added / sold on a regular basis and Two, I felt that the net risks I took there did not match to the net reward I could gain (unless I got lucky and invested a big amount in one company which then took off vertically – but then again, I know Luck has never favored me and I don’t see why it will change now 🙂 was wroth the risks I took
But the bigger change in me has been to question as to whether we are dreaming as to the rise of India once again and one that would give us absolutely great returns of the kind that say United States had back in the 1980’s.
Much of the growth in the world has been due to the policies and the actions of one country and one country alone – The United States of America. And the de-growth which I am anticipating is also because of that one country.
After the World War II, only one country escaped unscathed – United States. Europe was devastated while much of Asia and Africa were still under colonization and had very little industrial infrastructure of knowledge to speak off. Japan lost not just much of its young population to the war but also its Industrial cities which were thoroughly destroyed by the US.
This left US as the key to future growth of the entire world and US Dollar the one and only safe haven among the plethora of currencies (though it did not happen till a couple of decades later)
While Europe did recover from WW-II, it never has been able to regain its prescience in the world economy. While the US economy continued to dominate, we saw the emergence of 3 countries from Asia who have come to dominate in the last 40 – 50 years.
The first country to rise was Japan – aided extensively by a weak yen, Second came South Korea – again a weak currency helped and third China – well once again a weak currency helped here too. Other than weak currency, all three had one more thing in common – they all focused on manufacturing led exports and for all three countries the biggest country for their products was US.
While we talk about our Current Account Deficits, the US too has followed a similar path with ever growing negative trade balance. But what tilted the favor for them was that unlike India or for that matter, any other country, US paid by its own currency which meant that in the worst case basis, all they needed to do was print more and print they have been doing – more extensively than ever before after the 2008 crash.
For a long time (in the heady days of the bull market of 2003 – 2008) it was felt that even if US slowed down, it would not affect the growth of the world economy since China and India will be able to replace the demand and hence sustain the net growth.
But the events past 2008 showed that absent US growth, there was not much anywhere else with almost all countries going with one or the other kind of stimulus. But stimulus is like a drug, it boosts the performance in the short term but costly in the long term (as India is currently finding with high inflation which has resulted in higher interest rates).
Both the initial recovery post 2008 and the recent recovery in markets (developed markets) has been due to the quantitative easing in US. Almost all countries enjoyed the flow of money which came from US due to the attractive arbitrage that was available.
The broader opinion was that with US economy getting back on its rails, world economy will be good once again. This seems to have been proven right to an extent going by the falling unemployment and rising housing prices. But somewhere,something has gone wrong.
One, while US housing prices are going up, one saw a reversal in May after falling for the last 5 months. Second, the assumption was that once growth came back in the US, it will result in growth for all export oriented countries and we will be back to where we were prior to the crash. But the recent carnage in developing markets seem to have put a spanner in such views.
While US markets seem to be booming, economies which are dependent on commodities for a large part are seeing massive problems (Brazil / Russia / Nigeria / Australia among others). Now, growth without commodity growth is something that cannot be visualized.
India had not been affected since we export services rather than commodities but we seem to be facing another problem. Since we run a large CAD, we require continuous inflow of US Dollar. Other than exports, major source of Dollars is via FII investment in Debt (much larger than equities) as well as investments by NRI’s.
The problem we are facing is that since Interest rates are rising in US, FII’s are finding it not as attractive as before to invest in India. This pullout has led to a massive fall in Rupee with the Rupee touching 60 against the US Dollar. While a depreciated currency is beneficial for an export led economy, we having a Current Account Deficit will see whatever advantage lower commodity prices give being washed away due to the weak rupee.
The recent US rise has been once again led by housing but with interest rates firming up there as well, it remains to be seen as to how long they sustain since its one thing to borrow at 3.75% and yet another to borrow at 5.0% especially when the economy itself is growing at less than 2%. Another reason for the housing boom was due to a large number of big players entering the market (Blackrock for example). But as price goes up, they will be willing to sell and hence one should or may not see the rise in price to continue.
Then there is the Japanese Syndrome. Way back, in the heady bull makets of 70’s, Japanese were pretty big spenders but after the economy went into doldrums, life has never been the same again. Japanese are happy to keep the money in bank deposits at virtually no return rather than take risks or spend the amount. In fact, this attitude is not just of individuals but also banks who prefer to buy Japanese Government Bonds than try to lend it out side.
While Americans may not just yet stop buying, I believe this is a concern that should not be overlooked. After all, the damage to American families of the fall of 2008 has been severe and one cannot expect them to make merry even though their savings are absolutely nil.
One major expectation in India is that once Modi becomes the Prime Minister, the worst maybe over and India will tread the golden path. But how true is that. Vajpayee was one of the best Prime Ministers one could have expected but the markets didn’t budge much other than the brief rise in 2000 due to the global IT boom. MMS arrived in 2004 and while he did nothing much, markets more than tripled. The reason for the difference – International Markets once again.
Indonesia became the first country to raise interest rates to try and stabilize the Ruppiah. With Rupee now closing in on 61, its no wonder than Bond markets in India seem to feel the same. If and if that happens, that should be the final nail in the coffin of the growth story of India.
My own sense is that markets may not go anywhere in the forseeable future and in that I mean for the next 2 – 3 years. While that does not mean there would not be opportunities for the trader, for an investor, it could continue to be a painful time ahead.
Disclaimer: I am not an Economist or have even studied much of Economy and hence I can be very well wrong with my hypothesis (and I will be happy to be wrong). But I believe that if my logic is right, the best place for investment in the current climate will be Banks and Inflation Indexed Bonds via Mutual Funds. On a Risk Adjusted basis, there will be no other asset class that can come close to it in terms of Risk Adjusted Return.