New Delhi: Negative economic news such as inflation, rising interest rates, decelerating growth and lately, the earthquake in Japan have prompted international investors to flee Asian stocks.
However, things are not as bad as they look. (Also read this)
Citigroup Global Capital Market’s lead indicator index, or LEI, is pointing towards continuing economic expansion. What’s more, it seems to be pretty good at spotting stock market trends, according to Marcus Rosgen & Co who calculated that the correlation between the LEI and equities is positive and stands at 0.6.
So, what is the LEI currently telling us? Well, the LEI is showing that, incrementally, things are getting better, not worse. At its worse point in the current cycle, the LEI reading stood at -88, and now the LEI is at -61. So, all the lights aren’t flashing green, but there is certainly more amber around than there was red….The bottom line is that, incrementally, things are getting better from a growth perspective, not worse. Until the LEI rolls over (the LEI includes Japan) and excess liquidity in Asia ex evaporates, it is wrong to call for a bear market, especially at current multiples.
But then, aren’t the factors that lead to economic expansion - interest rates and input costs trending towards the danger zone where they will start hurting growth?
After expanding for two years, growth, according to Citi, has historically moderated in the third year due to a high base effect. This makes markets move side-ways for some time. Subsequently as real interest rise (real interest rates are negative in most emerging markets now), markets are expected to gain momentum.
Citigroup analysts note:
The points to note are that, real rates rise and, rather than markets falling, the market actually rises with higher real rates. The same is also true when it comes to earnings. Real rates rise and earnings follow. This is why equity markets do go higher as interest rates rise. And markets rise until valuations hit such high levels that any increase in interest rates destroys future growth potential and prices fall.