Has Risk-Off entered in a Bubble Zone?

Lately there been a headline shocker here in India, when Q4FY12 growth came at 5.3%. Though for market, it was an anticipated event and so market reaction to the news was highly indifferent. As we have said in the past, market movement at least in near term will be influenced globally by events happening in Euro-Zone.

Here we discuss our views in two parts – our view on domestic issues and our view on global issues.

Fall in GDP growth is certainly a matter of concern, but as far as its impact on markets are concerned, we believe this slowing down of India’s growth is already there factored in the way Indian stocks are valued right now. It’s not to deny the fact that we would have done much better had governance and policy making been better and forward looking in India. But the fact is that we always had political deficit in India and nothing is new about this. Idea is to see ahead. During 2002-2007, when global liquidity surge had taken place and cross border financial transaction had increased from absolute value of US $1.8trillion in 2002 to almost US$6 trillion in 2007, India with its strong investment appeal was a large beneficiary. And now with reversal of the same India is also bearing the pain of this global de-leveraging. Since March 2008, around US$6 trillion of funding lines has been eliminated by banks. Now, Emerging markets cannot count on ability of remittances, donor flow or portfolio investments to offset the declining bank’s leverage globally. Although there will be spurs of portfolio or carry trade investments, we believe the flow would remain highly volatile, with extended “dry spells”. Like the spurs in fund flow we saw in month of January and dry-spell that we are witnessing thereafter. But there are opportunities as well; Japanese companies are sitting on US$ 2.6 trillion in cash. And, in last three years in all the large ticket investment deals in India, Japanese were the buyers. Also financial markets are self correcting and if we look at Indian Rupee depreciation and fall in crude prices, things are correcting very fast as far as India is concerned. Latest trade data for April clearly suggests that Import is slowing, while export is increasing. If current trend persists for few months our quarterly trade deficit will become much lower than current US$ 15 billion. Consequently it will ease pressure on Rupee. And as core inflation is consistently below 5%, this will give RBI governor room to go for aggressive easing of interest rate and that to us is the trigger we require for a new structural bull market to start in India.

Globally, things will depend a lot on how Euro Zone issue pans out. And it is so political in nature that not much can be predicted. We are tracking five key data point to keep us ahead of events. Dollar Index and bond yield in US, Germany, Spain and Italy. Stability in global financial market will be suggested only when dollar index and bond yield in Spain and Italy falls and bond yield in US and Germany rises. Till that time it’s Risk-Off.

Structurally, we see a bubble getting formed in the name of Risk Off. US’s and Germany’s 10 year bond yield has halved over last one year. That means, if you were holding Government bond of US or Germany, your money has doubled in one year. That’s too much return from a so called risk free instrument and simple unsustainable. And that means a bubble is there in this Risk –Off regime. And like any other bubble, one cannot time –when this bubble will burst. But for a prudent investor that’s a suggestion that shortly it will time to put money on Risk-On regime.

Valuation by any method is on the lower side as far as equities are concerned and so whenever the regime changes, return for equity investors will be quite high. Yes, whether this regime change will take place in U shape or V shape or in L shape, it’s too early to frame a view on that.

 

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