|
|
|
Heightened Volatility
The Great Moderation (view that in the West we have entered a period of good growth with low inflation) has come unstuck with a thud. We are if anything entering the age of unprecedented volatility. It is like a stretched rubber band when stroked causes vibrations – the longer the band, the higher the vibrations. In real terms, the G5 went on to become G7 to G11 and at last count to G27. So, there is 5 times as much saving and consumption to deal with, without recourse to a central banker that can administer policy on a global basis. And it is more than just capital, it is increasingly also labor that is impacted. Transnational immigration on the heels of de-growing populations in the West is bringing home volatility to the main street. Send-people-send-them-back policies are creating stress on both sides which invariably leads to protectionism further aggravating the dis-balance. We are in the uneasy adjustment period where we are only about beginning to grapple with global mass movement of capital and labor. We don’t know how to approach it, much less what levers to pull on – not just the European Union, welcome to the Global Union! It is interesting that the impact of this volatility will have an immediate concentrated impact on – the US as the consumer, China as the manufacturer, India as the servicer and OPEC as the energy provider will face unequal impact and challenges to its economies. While we are in the midst of the first global shock, it will take us a few more to finally get a handle on this. Perhaps as an impact of the first shocks you will see the consumption and manufacturing getting spread more widely as a way of naturally de-risking the system.
Ever wonder why prices move dramatically for no apparent reason?
The price of large cap stocks at the margin on any day is driven by how much is bought and how much is sold. Since February, we have been seeing the Sensex slide gently from the 10,500 (Pre Satyam) to 8800 odd. You could be forgiven for thinking that the recession (globally, not India) has just got worse. Predictions of 7000 or even 6000 were popping up. When large index like the MSGI or the S&P revises its economic outlook or adjust its index constituents, all funds tracking these indexes have to follow suit. The US markets have been on a powerful slide since January, putting redemption pressure on funds, which in turn sell securities to move to cash. Then a large macro event like elections are announced and funds sell in anticipation of uncertainty or the ability to buy at lower prices. All three of the above happened in Jan/Feb leading to the slide we saw reflected in the Sensex. The astute student of the market will observe is that these are all non-stock specific considerations, so literally the baby is getting thrown out with the bath water. A good stock like L&T or ITC gets hit purely on technical considerations which is what makes them under-priced. This is why looking at prices to drive value is a dangerous occupation!
Credit de-Growth
What does the constant reference to de-growing credit (98% even!) mean? Industry participants point to this in support of their claim that credit has dried up. Could it be exactly the opposite? At the peak, the risk premium goes down; it being the discount factor (denominator) it increases the price of all securities. The reverse happens in a panic where this risk increases drastically making a lot of projects that were viable with a lower interest rate no longer viable. This means that companies will withdraw some projects that don’t make sense in the revised risk regime. We have been seeing some of this with large SEZs being shelfed even at the risk of paying hefty penalties. This has the desirable effect of reducing supply in an environment that is already demand constraint and thus start the process of finidng a reasonable price. Now this is how the free-market does and and it is clearly not a painless process. So we prevail on the government to nudge interest rates lower. Now what if the Bankers find these rates too low to compensate them for the risk they now percieve? They stop lending, restricting supply thereby putting upward pressure of rates – text book economics!
Lower rates are always preferred but the market has to be allowed to find the clearing price. The same is the case with the bond market, Treasury’s high appetite for debt is not only crowding out the corporate borrowers with low credit ratings (Tatas did just fine with their over-subscribed issue) by very really increasing rates. While this may be counter to the RBI’s policy intent, one must remember it only controls the short end of the term structure.