Stock markets bracing for turbulence

Globalisation and its consequent inter-linkages of economies and stock markets have been hailed for the benefits it has brought to world trade. Countries with the ability to manufacture the product at the lowest cost – China,Korea,Indonesia,Taiwan,etc – did so. Countries with the ability to use its vast English-speaking engineer workforce laid its claim to be the back-office of the world.

Emerging economies needed capital and expertise to grow to their potential. With growing confidence,they opened up their gates and welcomed foreign direct investment into their economies and foreign portfolio flows into their stock markets.

The world was balanced out with export engines of Germany,Japan and China finding a willing customer — the United States of America. After the Asian currency crisis,lessons were learnt and emerging economies focused on exports and started building foreign exchange reserves.

The world’s largest importer was also the world’s largest debtor and its growing deficits between revenue and expenditure were readily financed by exporters who found US sovereign bonds one of the safest places to park their burgeoning reserves.

The world was in good balance; on the flipside the inter-linkages between economies and markets became so strong that any disturbance caused anywhere was certain to create ripples everywhere else.

Globalisation: Unintended Consequences

The US has finally entered into a double-dip recession after months of uncertainty. Europe,make no mistakes,is in a crisis worse than Lehman which blew up the world markets in 2008. Sure,Lehman was a big Wall Street bank,but this time,we are talking about countries: Greece,Portugal,Ireland. The debt-GDP ratio of the US,France and Italy are unsustainable. Standard and Poor’s has already taken away US’ AAA status – it has been holding this status since 1942. The Euro is in an existential crisis and if some of these countries are not allowed to exit the European Union in an orderly manner,the world may have to pay a heavy price.

Growth in China,India and Brazil is slowing down. The world was saved from a collapse in 2008 by steroids in the form of injecting massive doses of cheap liquidity in the economies of the US,Europe and China. This liquidity pumped up the commodity and stock markets across the world creating an illusion that all is well.

Markets,addicted to liquidity were clamouring for QE-3 which is nothing but printing more money. The US Fed,instead of playing into the market which it did earlier,wisely announced Operation Twist — buying 30 year US bonds which are at an unbelievable sub-3 per cent and simultaneously selling short dated paper. This will be liquidity neutral and also put pressure on the 10 year bond yields bringing interest rates in the economy,already low,even lower.

This spooked the markets and we are seeing a global sell off. Also,the dollar carry trade which had emerged stronger; borrow in dollars at cheap rates and lend in emerging economies where monetary policies are being tightened to combat inflation. In fear,there is a flight to safety and money moved back into the US Dollar. This trade unwound opening up severe gashes in the emerging market currencies. The Brazilian Real,Indonesian Rupiah and the Indian Rupee depreciated upwards on 9 per cent in days.

Domestic Woes

Unlike 2008,where India was impacted only by global factors with no worries on the domestic front,this time it is different. Policy inaction,an inflation that has remained sticky has led to 12 interest rate increases over a 19 month period pushing up rates which will impact investments and growth. In the next three quarters,we are likely to witness deceleration of growth in the Indian corporate sector.

The drop in savings and capital formation,difficulty in land acquisition,high interest rates of debt,environment and project clearance issues and the general loss of confidence in the environment has slowed down companies from announcing new greenfield and brownfield expansions that will affect future growth.

What does this mean?

We are likely to see further downside risk and high volatility in the short term. It is a fact that money is made when you have the courage to go against the tide and invest in gloomy environments. While all the traditional Wall Street wisdom has been turned on its head,investors need to remember the ancient Zen saying “This Too Shall Pass”. It will be wise to make systematic monthly investments either in a mutual fund or just buy the Nifty ETFs every month and then,patiently wait. If the US Fed yields to the clamour for QE-3 in meaningful doses,we will have a refuelling faster than we think.

— Author is MD & CEO,HDFC Securities