Impact of QE3 on Indian Equity markets

Let's Pray my monetary works this time.... 3rd time lucky!!

The world has spent most part of the last 2-3 years gripped in fear of a meltdown in the Euro-zone and its eventual breakup and a sustained slowdown in economic growth in the US. This has had its impact on equities market and other risky asset classes over the past couple of years. But the world leaders have been making all efforts to ensure no such financial catastrophic events occur. Quantitative Easing (QE) and bond purchase has been their most powerful weapon in this effort. The most recent round of QE which has been coined as QE3 and the simultaneous Bond purchase announced by ECB last month, would have its impact on the risky asset classes in the near to medium term for sure. Below i have put down my thoughts in the form of a Q&A session to make it sound interesting. 

What would you advise investors and advisors in light of the recent QE3 and ECB action?

With the ECB determined to do whatever it takes to preserve the euro and the Fed promising to buy securities in the open market until the US economic recovery accelerates, a substantial amount of downside risk to markets has effectively been removed. Given this unusual degree of support from the major central banks, we recommend advisors and investors to take a more constructive position toward risk and equities.

With the global growth environment expected to stabilize in the next few months, sizeable forthcoming liquidity injections by central banks are likely to lift risky asset prices to new highs, and investors should take advantage of that by moving out along the risk curve. This move is not being driven by valuations, but rather by extraordinary monetary policy support. For the rally to sustain in the longer term, an improvement in global economic growth would be required in the next few quarters, and hence we would recommend investors to also time their exit from the risky assets at the right time when valuations look stretched and not get caught on the wrong foot incase global growth falters in the next several quarters. However, that is not the story for this year as a new cycle of monetary support is just beginning, cyclical sectors continue to operate at low levels, and valuations are not overly stretched in a number of risky asset classes.

How would QE3 impact the economies of emerging markets and India?

Though QE3 and its liquidity flows into emerging equity markets would be welcomed by all but it would have an inflationary impact on the asset prices in these countries. Inflation has already been giving sleepless nights to the central bank of India and other emerging economies. Rising commodity and property prices would lead to a bubble sort of situation in the longer term. Inflation in food prices would hurt the larger part of the Indian economy stakeholders. However this liquidity flows would also lead to appreciation in the currencies of the emerging economies which would benefit the import bill of these countries. We believe the investors should capitalize on the near to medium term buoyancy in the markets till the liquidity pumping continues.

What is the outlook for Indian markets keeping in mind the other factors that our economy is faced with?

The deterioration in the fiscal position of India has left the government with little space to mitigate the ongoing economic downturn. IIP and GDP data have been on a downhill trip since 2010 and is yet to pickup. Furthermore, the government has been weighed down by a political environment that has curtailed efforts towards reform. The central bank has also made it clear that, with elevated inflation, it remains reluctant to reduce policy rates.

However, there are signs that things are starting to open up on the policy front. The recent actions to increase diesel price, reduce withholding tax on foreign borrowing, and to allow FDI in retail, aviation and other sectors have been important steps forward and could potentially mark an end to the policy stalemate. However, this has precipitated a political backlash including the withdrawal of support for the government by the Trinamool Congress. Reform initiatives are thus at an important juncture. Although there are risks of some backtracking in the face of political opposition, if the government can withstand the political upheaval unscathed we could see a relatively better dynamic evolving in the coming months where policy crisis diminishes, some progress is made on fiscal adjustment, growth picks up, and the currency recovers ground.

After seeing the steady flows into Indian equities, how do you see the trend ahead?

Flows into emerging market equity funds soared to $4.3 billion in the week ended Sept 19, from a meager $447 million the previous week, according to fund tracker EPFR Global. That drove these funds' assets under management up 0.6%, marking the second largest weekly inflows for the year. Indian equities have seen FII inflows in 2012 of around $15.9 billion till the end of Sep’12. This is one of the highest inflows ever seen and I believe we would close the year better than that seen in calendar year 2007 when we had $17.5 billion of FII inflows in Indian equities.  Previous rounds of QE1 and QE2 are associated with a weaker dollar and gains for higher-yielding assets, such as global equities and emerging market bonds and currencies. Similar expectations will now drive more capital into emerging market assets in the near to medium term.

Austerity measures failing as expected

In my earlier blog, why government austerity measures are a bad idea , I had mentioned how Austerity is a bad idea because it puts a spanner in the economic growth. Austerity alone does not deliver the rewards it is meant to and the threats of stunted economic growth and recession remain high in the Euro zone even today. Case in point is Portugal, a country that had taken the austerity route and followed all the rules but was still struggling with its debt problems.

There is a risk of that; look at Portugal, it has done all the right things, it has stuck to austerity, it has stuck to the programs set by the EU and others and yet Portugal's bond yields are incredibly high today.

The expectation from austerity was that markets reward countries for delivering austerity in the form of much lower borrowing costs and that hasn't happened. Despite the austerity drive, the euro zone was still plagued by talk of default and speculation that it might break up. These things effectively mean that austerity does not deliver the rewards it is supposed to deliver. The consequence is that you are left with countries that have zero growth, possibly recession and interest rates which are painfully high and that combination is unsustainable.

The failure of austerity put fiscal transfer back to the top of the agenda. Germany has been vehemently opposed to direct fiscal transfers from the better performing northern euro zone to the struggling southern countries. If they can't get the rewards from the markets, presumably there would have to be some kind of fiscal transfer mechanism to allow their yields to come back down. This brings the whole issue of what the ECB does, what happens with a fiscal union. It has to help these countries, not just deliver austerity.

Iran-West tension again setting stage for Oil to boil

Oil prices could spiral out of control and potentially herald deeper economic hardship for Europe if the European Union joins the US in banning Iranian oil imports. EU officials said that the European governments agreed in principle to ban imports of Iranian oil. China also suggested it would back US-led sanctions. But several countries within the EU are heavily reliant on oil imports from Iran, and none more so than economically struggling Greece, which currently imports 30% of its domestic oil from the country, according to the International Energy Agency (IEA).

Greece’s economy is already mired in deep recession and could feasibly collapse entirely if the sanctions were imposed. Were that to happen, the Greek economy could take its European neighbors down with it. But the likelihood would be that Greece would have to ignore the import ban and that the EU would have to allow it to in order to avert economic disaster.

Let’s assume the EU is stupid enough to go along with the US in imposing sanctions on Iran. That would only mean 250,000 barrels of heavy sour oil not coming into the EU. But the impact that would have on countries like Italy and Greece would be enormous, and the Greeks are not going to slit their own throats for the sake of an EU sanction when Iran is the only country willing to offer them oil on favorable terms. It would utterly destroy the Greek economy.

Saudi Arabia announced that it was ready to fill any gaps in the oil supply if needed, but market-watchers cast doubt on that possibility. Such a move by the Saudis would use up virtually all of that country’s spare capacity. The last time that happened, in 2008, oil prices climbed to almost $150 a barrel. Saudi Arabia’s continued ability to fill gaps in the oil supply in the future is questionable, considering, that its own domestic oil consumption could threaten its position as the world’s largest oil exporter and consequently pose a threat to the global economy.

Equally inflationary to oil prices—and dangerous for the global economy—is if military conflict breaks out between Iran and the West. Iran has threatened to close off the Strait of Hormuz following the announcement of US sanctions and given the already obvious tensions between the two countries fears over a military conflict have grown. Any such conflict in the Middle East between Iran and the US would have a catastrophic effect on oil prices.

What seems more likely however is an easing of tensions between Iran and the West before the end of the month, which would then feed into oil prices. My sense on the geopolitical situation is it’s saber-rattling on the part of Iran. If it were serious about closing the Hormuz Strait, I suspect it would do it first, rather than tell the world it was going to do it.

That view was reinforced when Iran’s foreign minister appeared to indicate at a joint press conference with the Turkish Foreign Minister that his country was willing to reopen negotiations over Iran’s nuclear program, suggesting the West had possibly won an international game of chicken. Of course, that may have been what the White House had intended to achieve all along. But whether it will have the ability to pull off such diplomatic tricks in the future is far from certain.

Buffett's Big Move in Shaky Market

It indeed seems, the God of Value investing puts in practice what he preaches unlike most other so-called market experts who make their living out of preaching others about investing. The article summarizes where Warren has been investing amidst all the market turmoil. 

http://www.cnbc.com/id/45259772

Euro zone loses appetite for Italian Pizza!!

The year 2009-10 gave birth to a new abbreviation which increasingly became more and more important for the World economy. That abbreviation is PIIGS - Portugal Ireland Italy Greece and Spain. A pig is generally considered to be a dirty unwanted animal and so is this PIIGS too.  

While Portugal and Ireland managed to get some bailouts and survive in 2010, Greece which was a bigger mess, does not seem to be all that lucky. The EU, IMF and G-20 has asked the Greek government to adhere to the austerity measures imposed upon it. I don't know whether the austerity measures would have any impact on the finances of the country, but it really did change someone's life - the Greek Prime Minister's, who had to resign under pressure. France and Germany with their heavy exposure in PIIGS, were forced to come to the rescue and also form the EFSF (European Financial Stability Facility) and convince G-20 and IMF about the bailout needed for Greece. For the time being it seems Greek default has been averted though.

When the world was taking a breather from the Greek drama over the past few weeks, Italian bonds seem to have given a rude awakening to the World at large. Italy is a much bigger economy than Greece and any run on the Italian bonds would be in effect a test for the survival of the entire European Union. France and Germany are not in a position to bailout Italy. I feel Italy may need to exit the Euro zone and revert to its own national currency to resolve its debt crisis, thereby forcing the break-up of the Euro zone.

With yields on its sovereign debt hovering around the 7% mark, market access may become limited for Italy. A forced restructuring of its debt could help solve some of its issues, but it would not address other issues that hamper the Italian economy such as a lack of competitiveness, a large current account deficit and lower gross domestic product. 

Neither the EFSF nor the IMF is in a position to bailout larger economies like Italy. Issuing more bonds in the Euro zone by the EFSF would lead to a larger pandora's box which would create bigger problems in the years to come. Its like a gigantic leveraged CDO being financed by the better performing nations and large emerging economies. Its a recipe that would leave a bad taste in the mouth. 

As I had mentioned in my previous blog why government austerity measures are not a great idea Italy is facing recessionary pressures on account of the cut in government expenditures. This would definitely make the high sovereign debt unsustainable. The only way to avoid a breakup of the Euro zone would be for the European Central Bank to become a lender of last resort, for a fall in the euro's value in line with the dollar and for fiscal stimulus for the "core" euro zone and austerity in the periphery to take place. Till this takes place, it seems Europe's fancy with Italian Pizza is done for the time being!!

Higher taxes for Wealthy Americans

There is news that US President, Barack  Obama would be proposing what is being called as "Buffett Tax" on people earning more than $1 million a year as part of his deficit-cutting recommendations to the US Congress.

The purpose for such a tax is to bring the tax rates of the wealthy Americans in line with that being paid by the middle class Americans.  Warren Buffett had once famously said that he thinks that he, and other super-wealthy Americans, don't pay enough in taxes. He said his tax rate is 17.4% whereas most middle class Americans pay 30% or more in income tax. It’s really an irony that cannot be explained by simple economics!

No wonder Capitalist America took it so long to realize as to who needs to be taxed more and who less. Taxing the rich and leaving a little more extra cash in the hands of the middle class could definitely change the dynamics of local consumption significantly. It’s vanilla economics, that the marginal utility of a few thousand dollars in the hands of a middle class is much more than that in the hand of billionaire!

In his weekly radio address Obama said that Americans need to be ready to "pay their fair share" to narrow the U.S. deficit, previewing his proposals to Congress. Obama has repeatedly argued for the wealthiest Americans to face higher taxes with fewer loopholes and exceptions as part of the effort to ensure the U.S. debt-load remains in control. In addition to floating the idea of more taxes on the rich, he is also expected to propose companies getting some tax breaks.

It’s no wonder that the Republicans, who have raised the volume on Washington's fiscal problems as the November 2012 presidential election nears, see higher taxes on the wealthy as a problem for jobs, given that entrepreneurs and companies would be strongly affected. It’s really an unfair world where the rich would go to any length to arm-twist the government in preserving their wealth whereas the middle class has difficulty in even building a cushion for tough times.  

Why Government austerity measures are not a great idea

The current global crisis has given governments a new weapon to tackle the precarious situation being faced by them - Austerity measures. Financial times lexicon defines Austerity measure as "An official action taken by a government in order to reduce the amount of money that it spends or the amount that people spend". But doesn't classical economics teach us that in order to come out of a recessionary economy there needs to be increased spending and consumption demand in order to stimulate industrial activity?

US President, Barack Obama announced a $ 447 bn package that would create jobs in the economy through infrastructure spending and government spending. This is definitely a step in the right direction, unlike what governments in Europe are resorting to. Cutting down government spending, pensions and salaries would see its repercussions over a longer period of time. It needs no economist to tell you that these activities would lead to lower local consumption, lower industrial activity, more job cuts and the cycle would get more painful with time.   

What really is needed is a change in habits of the people. Though a difficult thing to ask but then difficult times need difficult measures. This change in habits is something that would come with time. The concept of savings and spending within your limits is something the Europeans need to learn from the conservative Asians. Leverage and Debt is the single most important cause of all problems that the world is faced with now. Asians are known to be conservative investors and that has definitely helped them to sail through the current turmoil. Indians in general have a very high savings rate of 33% of their earnings. I think its not asking for too much if one is advised to spend within their limits. 

By austerity measures, governments are punishing the common man for the wrong doing of the politicians and the financial market culprits. People could also vent their anger through protests and strikes like the ones seen in Greece recently. These cannot be suppressed for long and has the power to topple governments. Instead of passing the buck of austerity on the common man in Europe, it is important to bring the bankers and financial engineers under some sort of regulation wherein a check must be kept on the leverage these guys are taking on their banking assets. Greed for higher returns and commissions has rocked the ship earlier and would do so again in future unless there is some check to keep these in limits. Investment bankers and Wall Street bonuses which defy gravity even in recessionary economy is a clear indication that the very systems which run and govern the Zillion Dollar global banking and financial markets have inherent flaws that is working in favour of a few and against the majority.

2008 being revisited in 2011

2008 was a year that very few people would forget in their lifetimes. You need not be linked to the capital markets to remember the events of 2008 as almost all across the Globe and across all sectors, the tremors were felt with varying intensity.

Now as we have come to the middle of 2011, the fault-lines are starting to show up again. Indian markets started the year with a strew of negative events - big ticket corruption being unearthed, high inflation, rising interest rates and high crude oil prices. Developing markets continued to outperform the emerging economies as economists went gung-ho about the growth prospects of the shattered developed economies. US was seen as the clear market leader in the global rally. Unfortunately the party on the street has become very short lived.

Unlike 2008 when it was the "Too Big to Fail" banks from the US which were at fault and collapsed, this time around in 2011 its the Sovereign Governments whose neck has been put on the line. Countries which till yesterday figured as the top tourist destinations of the developed world, became the poster boys of Sovereign defaults. These countries made it clear to the world, either the European Union (EU) bails it out or there would not be any EU tomorrow. What initially looked like a European problem, soon raised its head in none other than the mighty USA. With the Debt Limits becoming a national political issue in the US, the world could do little but watch the debt limits being raised to another astronomical figure of a few more trillion dollars!!

Now with fresh concerns of European banks falling, the markets are on tenterhooks!! People are talking of a Lehman type crisis in Europe. Growth rates are being downgraded for the developed and emerging economies and also for the World at large. Where would all this lead to? Has Lehman become the synonym for financial crisis? Before we could lick our wounds from the last crisis, we have been pushed into another one and this time around the wound seems to be quite deep. Governments are in trouble unlike the previous case when governments bailed out the banks. Fed cannot come to the rescue of the US government by running its minting machines overtime. That would be the silliest thing to do.

The problem with the current global economy and more specifically the financial sector is that greed has become the corner stone of its demise time and again. We do not seem to be learning from our past mistakes. We pumped in $700 bn in 2008 and created the current mess. Now debt limits are raised further and stakes are higher. Its no man's guess what the size of the next crisis would be.

Is China the next Dubai

To question China's relentless and inevitable rise to the top of the world's economic pyramid today is to invite ridicule. Investors like Jim Rogers have long thought that China is the only worthy investment story on Planet Earth. Anthony Bolton, the United Kingdom's answer to Peter Lynch, recently threw his hat in the ring, emerging from retirement and moving to Hong Kong to start a China fund. Other China bulls have predicted that the Chinese stock market could overtake the United States in terms of market capitalization within three years.

This is heady stuff for a country that didn't even merit its own chapter in the World Bank's "The East Asian Miracle: Economic Growth and Public Policy," published only 15 years ago. Back then, it was all about Japan and the Asian Tigers -- Taiwan, Singapore, Hong Kong, and South Korea. Even today, China is a story of remarkable contrasts. Yes, it boasts currency reserves of $2.3 trillion, making it, by that measure, the richest country in the world. But China also is a country where 200 million people live on less than $5 a day. Understanding that China's rise won't happen without some serious bumps along the road is the key to making -- and keeping -- money from the "China Miracle." Is China the Next Dubai: Lessons from the Tiny Emirate Superficially, Dubai's rapid development from speck of dust in the desert to mirage made real is not that different from China. Cheap financing combined with world-class aspirations fueled Dubai's property boom that included the world's tallest building, the Burj Dubai. Dubai property prices doubled between 2005 and 2008, as commercial and residential real estate in the middle of the endless desert became as expensive as cramped quarters in New York and London. The emirate's rulers even targeted a China-beating annual GDP growth of 11% to 2015. Eighteen months later, the vacancy rate for Dubai office buildings is 40%, even as planned new construction is set to double the city's office space over the next two years. China bulls will dismiss uncomfortable comparisons with Dubai with a knowing chortle. After all, the population of China is a thousand times greater than the tiny emirate's. And Dubai's $50 billion GDP is less than the economic wealth that China has generated in the last three months. Yet, perhaps this is precisely the reason you should pay attention to the rising din of China critics. Even as the media falls all over itself to praise the remarkable efficacy of China's $585 billion stimulus package, "Bond King" Bill Gross of PIMCO made investors squirm when he observed that the all-knowing economic philosopher kings running the Chinese economic show may inflate... gasp!... a bubble of their own.

Is China the Next Dubai: The Sin of Over-investment? Much like little bubble brother Dubai, the problem in China is best summed up in a single word: "over-investment." Even as U.S. and global consumers are closing their wallets , China is building more steel, more factories, and more malls for which there is almost no demand. Much like in Dubai, many Chinese skyscrapers stand empty, even as whole new cities are being built where the vacancy rates are as high as 75%.

One blogger described one of Beijing's leading malls, "The Place," as "stunningly dysfunctional, catastrophic... with fifty percent of the eateries in the basement boarded up. There is simply too much stuff, too many stores and no buyers." Perhaps no project better illustrates China's dilemma than the spectacular, $450 million Bird's Nest Olympic stadium, designed to last for 100 years and withstand a magnitude-8 earthquake. Yet, the stadium now stands empty, with paint peeling ignominiously from its slick girders. "You build it and they will come" is a better Hollywood movie plot, than a sustainable development strategy. Scratch the surface behind China's impressive growth numbers, and they tell an unsettling story. Consider that 19 out of 20 dollars of China's GDP growth this year is from investment in fixed assets -- empty malls, ghost cities, and tens of thousands of bridges that lead to nowhere. China is investing at a pace like no other country in history.

Post-war Germany achieved a peak investment to GDP ratio of 27% in 1964; Japan's peaked at 36% in 1973, and South Korea's at 39% in 1991. The comparable number in China today is 50%-plus. Yet, not only are the Chinese building a lot of stuff they don't need, they also are getting a heck of a lot less bang for their buck. From 2000 to 2008, it required $1.5 in debt to produce $1 of GDP in China. Today, it takes $7 of credit to yield $1 of growth in GDP. No one has done that poorly since, well, the bad old days of the Soviet Union. Is China the Next Dubai: Enron Revisited? The knives are coming out to make money on China's collapse. Jim Chanos, founder of the investment firm Kynikos Associates and iconic short seller, has put the Chinese market in his sights. Chanos made his reputation -- and a good chunk of his fortune -- as one of the first Wall Street analysts to see that Enron's earnings were pure fiction. Chanos believes that much like Enron, inconsistencies in China's statistics -- like the surging numbers for car sales but flat statistics for gasoline consumption -- confirm that the Chinese are simply cooking their books. The Chinese even have a phrase for ripping off foreigners: "Neng pian, jiu pian" -- "If you can trick them, then trick them."

The bad news is that, if Chanos is right, the collapse of the Chinese economy will be 100 times worse for the global economy than the brief hiccup that was Dubai. If China's economy stops running hard, it will have profound effects on its ability to finance the exploding U.S. deficit. In Chanos' view, the slowdown in China may be as big of a watershed event for world markets as the subprime collapse was in the United States. Little wonder that he is betting the farm on shorting China's economy. For students of financial history, the coming collapse of China is as painfully obvious today as it will be to others with the benefit of 20/20 hindsight. That doesn't mean that China won't eventually emerge as a global economic power. After all, the rise of the United States from a tiny country of 2.2 million people in 1800 to the world's leading power a century later was punctuated by at least half a dozen financial manias followed by depressions.

But as the British economist John Maynard Keynes observed, "in the long run, we're all dead." If you have a shorter time horizon, batten down your investment hatches. The investment seas may get rough.