As always, it is hard to judge whether the recent sell-off in the equity market is a temporary wobble or the harbinger of a steeper fall in the days ahead or the first stage of a slow-motion meltdown that will take place over the next several quarters. But it is sensible to recognize that any of the three outcomes is possible right now.
So, it is disconcerting to see analysts and fund managers being almost uniformly confident that equity prices will bounce back in the coming weeks. The various newspaper reports that liberally quoted these experts over the weekend have thus tried to assuage fears rather than assess risks. That’s unfortunate, because investor money is at stake.
The four-year bull run in the global stock markets has survived many temporary scares, but the problems that are building up in the US economy right now are of a more serious nature than ever in the recent past. There has been a lot of talk about the “decoupling” of Asian and American markets, with each going in different directions. But we cannot, as yet, ignore what is happening in the world’s largest economy and the fount of global liquidity.
The immediate problems emanate from the US credit markets. Lenders are sitting on at least $100 billion of losses in subprime mortgages, or housing loans made to people with poor credit histories. Two hedge funds run by Bear Stearns have been wiped out because of their subprime losses. A couple of high-profile bond issues to finance leveraged buyouts (LBOs) have run into trouble. Interest rates on corporate bonds that do not boast of the highest credit rating have started inching up. There is undoubted trouble in credit land.
Spreading credit woes could lead to a credit crunch and a US slowdown—which is bad news for equities in the long run. So the key issue is: Will the troubles in the credit market ripple out into the equity market and eventually the rest of the US economy as well?
Perhaps not. For example, a drop in the interest rates on high-quality bonds last week has balanced the rise in the interest rates of junk bonds. So, net credit conditions in the US are still quite easy.
But the mere possibility of trouble ahead has got investors worried. Various indicators—from bond spreads to credit default swap rates to various measures of volatility —show that there is now a palpable fear over the city. Money is seeking safety. And emerging markets, which are considered to be relatively less safe, are likely to be hit by this repricing of risk.
And what about India? The Indian economy, of course, continues to coast along in the fast lane. The International Monetary Fund (IMF) has recently increased its forecast for Indian economic growth this year.
The macroeconomic situation is stable. The fiscal deficit continues to drop (though not fast enough) and capital flows can finance far larger current account deficits. And, despite clear signs that profit growth in the corporate sector is slowing down and new capital expenditure is eating into cash flows, there is little cause for worry.
So, the fears continue to be global rather than local. But it is very difficult to separate the two in these times. We have had a synchronized global stock market boom in recent years, as capital markets across the world were joined together by torrents of global liquidity. So, it is likely that, despite domestic strengths, the declines, too, will be similarly synchronized.
Despite the rise of India and China, the US continues to be the main driver of the global economy. Even Japan and Europe will have to do a lot of work if they are to step in to support global growth in case the US stumbles. It’s a complex world out there—and investors would do well to realize this, rather than continuing to treat the equity market as a one-way bet.
Will the Indian market be hit by the problems in the US credit markets? Write to us at firstname.lastname@example.org