Mumbai: The strange thing about the rally that has lifted the Sensex to new records is that it’s completely at odds with the mood in the market. The pros of Dalal Street are far from being their usual bullish selves, preferring to lace their advice with uncharacteristically large dollops of caution.
Forget about euphoria, even normal high spirits, found in abundance on the Street, are completely absent.
Yet the reasons for the rally seem fairly straightforward. Inflation and its consequence, in the shape of higher interest rates, have been a worry for investors and the resurgence in the market has, as its basis, relief that the ghost of inflation has been laid to rest and the Reserve Bank of India is, therefore, unlikely to raise interest rates.
That plausible story is buttressed by the rise in banking and real estate stocks. Even the battered auto counters have shown the first faint stirrings of life. The 10-year bond yield has fallen below 8% for the first time since April. Surely lower interest rates, or at least stable rates, are reason to celebrate. Why then are so many in the market so sceptical?
The appreciating rupee is a big concern, affecting a swathe of industries. It isn’t only the information technology sector that’s hurt by the rise of the rupee—textiles, hotels, auto components and generic pharma exporters are all in the same boat. Commodities too are affected, because the landed price of imports comes down, the recent cut in steel prices being the latest example.
And while interest rates may have topped out, that still leaves them considerably higher than where they were this time last year. Recent auto sales have not been encouraging, indicating that demand has been badly hit. Wage bills continue to mount. In short, the forthcoming first quarter results have the potential to throw up some nasty surprises.
Also, with so much money going into new issues, there’s always the worry that there’ll be less left over for the secondary market. And the old complaint about the Indian market being overvalued still holds true, with several sectors trading at premiums to emerging market averages, although the market is off its highs in terms of relative valuations.
Why then are stocks going up?
Well, it’s not just the Indian market that’s rising—market indices in Hong Kong, Korea, Indonesia and the Philippines all rose to new records. Both the MSCI Asia-Pacific Index and the MSCI World Index have surged to all-time highs in recent days.
It’s clear that stocks are rising, not on account of country-specific reasons, but because of a renewed surge of global liquidity, a surge that has so far been high enough to cover some very jagged rocks in the debt markets, also known as collateralized debt obligations.
At the time of writing, worries over the sub-prime mess in the US affecting other assets seem to have been drowned in the liquidity, with yield spreads between emerging markets bonds and US treasuries going down.
As global independent research outfit Bank Credit Analyst says, “The market appears to be acknowledging that the latest disruption is more a reflection of credit concerns, unlike the February move, which was also accompanied by (unrealized) concerns of broader financial systemic risk. Bottom Line: the shakeout in sub-prime debt is not over, but may now be contained to lower quality securities, with less risk of a contagion into credit spreads and the banking sector.”
Money can certainly paper over a lot of cracks.
The rise in liquidity has fuelled a wild four-year party in asset markets and has almost made the risk premium an endangered species. But the worry that surfaces with increasing frequency is: what if it softly and suddenly vanishes away? How will it all end?
There are two end-of-party scenarios, admirably outlined in a recent speech by Malcolm Knight, general manager at the Bank for International Settlements. He says that the end game will depend on whether the liquidity is the result of central banks going on a money-creating binge or whether it is the by-product of a more fundamental imbalance between global savings and investment.
If you believe the former, we may be nearing the end of the bash, because central banks across the world are tightening, the latest example being provided by the Bank of England (though Japan continues to hold out).
On the other hand, if you believe with Ben Bernanke that the asset inflation is on account of an excess of global savings over investment, then it’s not only possible that the party will continue for much longer, but it can even get wilder.
As Knight puts it, “It is difficult to say which factor will be the key determinant in the future, in terms of risk in global financial markets. Since saving-investment imbalances evolve slowly over time, one would expect that the observed changes in yields and spreads will be reversed only gradually. But a further prolonged period of low interest rates and tight spreads of the sort that is implied by the saving-investment hypothesis risks encouraging even more leveraging in the short to medium term. The further build-up of global foreign exchange reserves could have similar implications. This suggests that the current episode of ample liquidity may be longer, involve a continued build-up of positions, and have an even more uncertain resolution than one might at first have expected,” he adds.
Simply put, the Apocalypse may loom ahead, but it is not nigh and we may as well enjoy the festivities while they last.
Mint’s resident market expert Manas Chakravarty looks at trends and issues related to investing in general and Indian bourses in particular. Your comments are welcome firstname.lastname@example.org.