EUROBOR-OIS Spread- warning signal for EU sunami

Last week both, globally and domestically markets faced huge volatility. Nifty at the end of the week was down by 2.1% Europe was down by around 1.5 to 2% while US dow Jones was up by 1.4%. Europe and US did better primarily on the back of rally last Friday after closing of Indian market. The rally was on account of some improvement in EU macro environment.

Volatility emerged primarily on account of rising bond yield in Italy suggesting – Italy may go Greece’s way. Mind you, Italy is 10 times bigger than Greece and when EU leaders are facing uphill task containing Greece’s issue. For them Italy may become impossible and the worst fear of an unsystematic default in Europe inducing contagion may take place. For market participants, this is like re-leaving post Lehman day’s horror. 

Thankfully on Friday some sanity looks possible back as far as Europe is concerned. Greece finally has a coalition government led by former central banker Lucas Papademos. And Italian Premier Mr. Berlusconi,   who was an obstacle to serious economic reforms in Italy, has resigned.  

Markets have become highly dependent on news flows. And nature of news is varying almost on a daily basis, making investment and trading difficult. One data point that helps us track this uncertainty and be ahead of curve is European money market. In fact, among all kind of financial market- it is money market that gives first hint of risk. Currently EUROBOR-OIS spread becomes important in this regard. This spread had fallen to 70 after making high of 86 in the beginning of October that helped global market rally in the month of October. But recently it made new high of 91 when Italy issue cropped up and consequently start of November had been bad. Now last Friday it has fallen to 86. Analytically, our assumption is that, only if this spread crosses 100- it will suggest emergence of contagion in Europe. 

Domestically, Gloomy corporate results and weak IIP numbers caused Index to close below 5200 at 5168. In fact Indian market has become more so dependent on the global flow, as domestically whatever that could have one gone wrong, has gone wrong on macro and policy front.

In terms of on-going Q2 results, SBI good headline numbers but bank’s net non-performing assets to net advances has increased to 2.04% from 1.7% a year ago and is highly alarming.

Among other results, Tata Steel and Hindalco reported lower than expectation results due to global uncertainties and higher raw material prices.

Going forward, we understand high risk nature of current market structure, but that is nothing new for equity market and this high risk going forward will certainly result in high returns, if one invests with discipline. We recommend buying diversified funds as well as selective large cap stocks. On declines, consumer staples stocks Hindustan Lever, Colgate and Gillette looks attractive for investment. 

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