The decoupling thesis plunges over the cliff

The decoupling thesis plunges over the cliff
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First Published: Sat, Jan 19 2008. 12 23 AM IST
Updated: Sat, Jan 19 2008. 12 23 AM IST
Friday’s steep fall took the Sensex down 10.3% from its high of 21,206 points reached on 10 January. The speed of the fall has been unnerving but then, so far, we in India have scarcely been affected by the carnage going on in the world equity markets.
If a bear market is defined traditionally as a 20% drop from a market peak, then global markets are perilously close to it. The MSCI indices of nine markets in the developed world are trading at 15-19% off the levels they were at three months back. That includes Japan, down 17.6%, and Singapore, down 17.4%, (data for three months to 17 January). The MSCI World index is down 14%.
Emerging markets haven’t escaped the sell-off. The MSCI Emerging Markets index is down 13.58%, but if you calculate the index from the peak reached on 31 October last year, it’s lower by 15%. The Far East countries have fared even worse, with the MSCI EM Far East index down 18.5% in the three months to 17 January. In the middle of this bloodbath, the Indian market has so far been the exception, with MSCI India up 3.46% in the three months to 17 January, although Friday’s dive would have sent us into negative territory. Malaysia, up 4.2% over the same period, is the only other Asian market in positive territory. MSCI China has fallen 26%.
The stars of the show have been the Gulf markets, thanks to their oil bonanza. The Saudi market has moved up 34% over the last three months, while Oman is up 25%.
The fact that the Indian market has been relatively insulated could mean two things: Either steeper falls in the Indian market are ahead of us or investors believe the relatively insular economy is a hiding place, albeit an expensive one, till the storms in the global economy blow over. The latter interpretation has been in vogue so far, with Merrill Lynch’s chief Asia equity strategist telling the media in Hong Kong that “Its valuations look steep, and it’s a crowded trade...but it’s the nature of lifeboats to get crowded. And there is some merit to the idea of India being seen as one now.”
But Friday’s steep plunge raises a question mark over that rosy interpretation.
The flip side of the lifeboat analogy, of course, is that the world markets are headed for a shipwreck. Recent falls in the US market have reinforced that worry, all the more so because the market has kept on falling in spite of plenty of soothing noises from the US Federal Reserve chairman. Ben Bernanke has recently, on more than one occasion, expressed his concern about the US economy and has indicated that he’s willing to reduce interest rates to stave off a recession. Recall how the first Fed rate cut last September sent the markets sharply upward, with emerging markets being the main beneficiaries. But this time the markets are far more doubtful whether rate cuts will work. They have ignored the Fed chief’s assurances, preferring to concentrate instead on the bad news of a looming recession. That’s a sure sign of a bear market.
Yet the year-end concerns about a seizing up of the inter-bank credit markets in the US and Europe have completely dissipated.
The one-month dollar Libor (London inter-bank offer rate, the rate at which banks lend dollars to each other) is at 3.96%, below the Fed funds rate of 4.25% and a percentage point below where it was a month ago. Similarly, the three-month Libor is at 3.93%, again a percentage point lower than what it was a month ago. And the Fed rate cuts have had an effect on the US mortgage rates as well, with the 30-year rate at 5.43%, much lower than the 6% it was at three months ago. Clearly, there’s plenty of liquidity now available with banks.
However, the issue is no longer liquidity, but the health of the big banks, on the one hand, and worry that the housing bust in the US is slowing down consumer demand, on the other. The reaction has been a rush to the safe haven of government bonds.
As funds flow tracker EPFR Global points out, “Investors pulled $11.2 billion (Rs44,016 crore) out of the US, Europe and Japan equity funds during the week end(ed) 9 January and removed another $2.4 billion from their emerging markets counterparts as they sought the safety of cash, defensive sectors and fixed income assets.”
The upshot has been that the US bond market is already discounting a US recession, with BCA Research arguing that real 10-year US bond yields (calculated taking their estimate of inflation expectations into account) are at their lowest level since the 1970s.
The Merrill Lynch January survey of global fund managers shows that most fund managers still believe that global equity markets are either fairly valued or undervalued and global bond markets overvalued or fairly valued.
But it also shows that the number of asset allocators that are overweight equities has tumbled, with a net 6% overweight the asset class, down from a net 20% holding this view in December.
The only ray of hope is that a net 32% of respondents were overweight cash in January, compared with 26% in December and 20% in November. That’s a sign that there’s ample liquidity waiting to be put to work, as soon as the uncertainty eases. Unfortunately, there are few signs of that happening in a hurry.
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 capitalaccount@livemint.com
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First Published: Sat, Jan 19 2008. 12 23 AM IST