The strength of the current four-year bull run has left few bears standing. One of the last remaining ones, Bill Gross, head of PIMCO, a global fixed income money manager with a staggering $600 billion (Rs24.6 lakh crore) under his care, threw in the towel a few days ago.
Gross used to believe in all the standard bear shibboleths— global imbalances, debt binge, liquidity glut—and he analysed in masterful detail how the good times could not last and the investment world as we know it would soon come to an inglorious end.
Not anymore. Gross has put on sackcloth and ashes, recanted from his bearish heresy and announced that so far he has had a deplorable tendency to see the glass as half empty. That impairment in vision has led to his funds underperforming the market and Gross now wants to make amends.
One way he’s doing that is by hiring Alan Greenspan, the legendary ex-chairman of the US federal reserve, as an adviser. The other is to see the glass as half full.
Worrier at heart: Despite his newly acquired bullish mindset, Gross is still uneasy about inflation
Before rushing to celebrate, however, it may pay to remember what happened when Stephen Roach, Morgan Stanley chief economist and long-time bear, changed his tune last year. On 1 May 2006, Roach issued what amounted to a mea culpa. Writing in Morgan Stanley’s Global Economic Forum, Roach said, “I must confess that I am now feeling better about the prognosis for the world economy for the first time in ages.” Why? Because “… it’s time to give credit where credit is due: First, to globalization for holding down inflation. Second, to central banks for collectively embarking on policy normalization campaigns. Third, to the stewards of globalization for facing up to the imperatives of architectural reform. And fourth, to Asia—especially China—for recognizing the unsustainability of export-led growth models. Notwithstanding the risks noted above—all of which need to be taken very seriously—I am delighted that the global economy finally seems to be taking its medicine.” Later that month, stock markets crashed around the world, with the Sensex falling over a thousand points on a single day. Let’s hope Gross’ turnaround doesn’t have similar consequences.
But while Gross may have stopped moaning about a slowdown, he remains a worrier at heart. This time, he’s uneasy about inflation. Isn’t globalization supposed to keep a lid on inflation, with the millions of workers in India and China forcing wages down and keeping goods and services cheap? Roach proudly cites his new adviser: “….special consultant to PIMCO Alan Greenspan has pointed out that the process of transitioning hundreds of millions of workers from planned economies to a market environment may peak in the next two-three years in terms of its rate of growth, reducing the disinflationary impact.” Apart from the maestro’s advice, Roach points to other factors, such as appreciating emerging market currencies, which are exporting mild inflation to the US and to increasing domestic demand in China, which at the margin will absorb excess savings and increase aggregate demand upwards, pushing up inflation.
But Gross is careful not to let this inflationary scenario cloud his new-found optimism. He develops instead an interesting theory, based on the fact that growth in the G7 economies is around 2%, while global growth is nearer to 5%. The low growth keeps money cheap in the developed economies and Gross says that that opens the door to an arbitrage opportunity, with funds from the rich nations flooding into emerging markets. It’s a kind of global “carry trade.”
So not only has Gross become a bull, he has also become partial to emerging markets and recommends investing in relatively liquid emerging currencies. The currency play allows international investors to participate in an emerging market’s growth via its appreciating currency. If more and more ex-bears—and they are a rapidly growing tribe—adopt this strategy, we haven’t seen the last of rupee appreciation.
China’s financial sector
Most of us draw comfort from the notion that while we play second fiddle to China in most things, our financial system is far superior to theirs. While our banks have over the years become much more efficient and have spruced up their loan books, the Chinese state-run banks are supposed to be the victims of state-directed lending, requiring frequent injections of capital to keep their balance sheets clean.
Evidence to the contrary comes from a new paper published by Albert Keidel at Indiana State University. The paper argues that Chinese banking is part and parcel of the government’s policy of ensuring low-cost funds for building the country’s infrastructure. Says the author: “The critical insight for evaluating these institutions is the realization that China’s commercial banks are not really banks. Despite their IPOs and foreign strategic investors, they are basically government-controlled deposit-taking institutions.” He says the banking system is actually an extension of the central bank, which is part of the government. In other words, this is not a market-based system, the bad loans are part of the country’s fiscal deficit and are a price that is being paid for the rapid transformation of the country’s infrastructure.
Simply put, you can’t compare Indian and Chinese banks—they are two very different entities. But investors, including savvy international investors, seem to love these Chinese non-banks—their valuations are much higher than those of the world’s best banks.
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 at email@example.com.