Will India remain in the shadows?

May 18, 2009 — Mitul Kotecha

Indian markets rejoiced in a big way following the outcome of the elections which put the secular Congress party back into power as the head of the United Progressive Alliance.   Stocks in India rose by a massive 17% and the rupee strengthened as markets gave a huge thumbs up to the outcome.   The margin of victory was bigger than had been expected and allows Congress to form a government with only minimal help from outside parties.  

Given that many had feared that the election would result in another unstable coalition supported by diverse parties each acting in their own interests,  the outcome was very positive.  In the event the result provides Congress with a strong mandate for change and reform.  The real question is whether they will grasp the opportunity or let it slip by and fall further behind into the shadow of China. 

There are of course many challenges that need to be faced on the home front including the alleviation of poverty for a huge chunk of the population, improving education, access to health care etc.   India also needs to move ahead with infrastructure spending, something which remains key to unlocking India’s potential growth and moving towards the pace of growth achieved by China.    As a comparison India spends around 6% of GDP on infrastructure spending compared to around 15% in China.   The results of such spending are obvious when looking at the pace of growth of both countries, with India growing relatively more slowly than China.

The issue is that even if the government has the mandate and the will to move forward with long awaited spending on infrastrucure, finding the money is the main problem.   The Indian government identified the need for $500 billion in infrastructure spending between 2007 and 2012 but the global financial crisis has seen a lot of potential investment disappear as banks bec0me increasingly strapped for cash and foreign investment shrinks due to lack of funding and an aversion to risk.   Restrictions on investments by funds that could potentially invest have also not helped whilst the government is limited in its spending by a huge fiscal deficit.    

The Congress party will need to grasp the opportunity that the election result has brought it and move forward to entice the investment needed to push forward with infrastructure plans.   One of the benefits of India’s slow pace of reform and gradual opening up of the economy is that the country has avoided the worst of the global economic crisis.  Even China will find it a huge challenge to shift its growth engine from export orientated growth to domestic consumption.  India is in a good position to take advantage of its relative resilience and now has a government with a strong mandate to do so.    It would be a great pity for India and the rest of the world, given the potential for the country to become a much stronger trading power, if the government did not take this opportunity by the horns once the celebrations are over.   If not, the rally in Indian markets may prove to have been a fleeting one.

Posted in Asia, China, Currencies, Economics, Economy, equity markets, Financial crisis, India, Indian election, Politics. Tags: , , , , , , , , , , , . Leave a Comment »

US dollar under pressure

May 15, 2009 — Mitul Kotecha

The US dollar has come under major pressure, with the US dollar index (a composite of the dollar against various currencies) falling to 4-month lows.   The weakness of the US dollar has been broad based and even the Japanese yen which normally weakens as risk appetite improves, has strengthened against the USD.  The euro has also taken advantage of dollar weakness despite ongoing concerns about the European economy. The main source of pressure on the dollar is the improvement in market appetite for risk.  

As I noted in a previous post, “What drives currencies?” risk appetite has been one of the biggest drivers of currencies in the past year.   This has pushed other drivers such as interest rate differentials into the background.   In the post I also stated that we would all have to watch equity markets to determine where currencies will move, with stronger equities implying a weaker dollar.

The dollar looks particularly sickly at present and it is difficult to go against the trend.  It will need a major reversal in equity markets or risk appetite to see a renewed strengthening in the dollar.   Although I still think it will require some positive news as opposed to less negative news to keep the momentum in equity markets going (see previous post) the prospects for a stronger dollar remain limited.   

Over the coming months the dollar is set to weaken further and those currencies that have suffered most at the hands of a strong dollar will benefit the most as risk appetite improves.  It is no coincidence that the UK pound has strengthened sharply over recent days, and this is likely to continue given its past undervaluation.  Other currencies which were badly beaten such as the Australian dollar and Canadian dollar will also continue to make up ground, helped too by a rebound in commodity prices.   

Aside from improving risk appetite the dollar may also come under growing pressure from the Fed’s quantitative easing policy, especially if inflation expectations in the US rise relative to other countries as a consequence of this policy.  It will be crucial that the Fed removes QE in a timely manner and many dollar investors will be watching the Fed’s exit strategy closely.  

Although the US trade deficit is showing improvement another concern for dollar investors is the burgeoning fiscal deficit.   The US administration revised up its estimate for the FY 2009 deficit to $1.84 trillion or about 12.9% of GDP, highlighting the dramatic deterioration in the US fiscal position.  Concerns about this were highlighted in an FT article warning about the risk to US credit ratings.

The deterioration in dollar sentiment has also been reflected in speculative market positioning, which has seen speculative appetite for the dollar drop to its lowest level in several months. The bottom line is that any recovery in the dollar over the coming weeks is likely to be limited offering investors to take fresh short positions as investors continue to move away from holding the dollar.

Posted in central banks, Commodities, Currencies, Economics, equity markets, Europe, Financial crisis, US, US administration. Tags: , , , , , , , , , , , , , , , , . 6 Comments »

How compelling are equity valuations?

May 12, 2009 — Mitul Kotecha

Relief over the results of the US bank stress tests, better than expected US jobs data, generally less negative economic data in general, as well as better than expected Q1 earnings provided markets with plenty of fuel over recent days and weeks. This has helped to spur an improvement in risk appetite and a resultant strengthening in equity markets. Meanwhile, government bonds have sold off, commodity prices have risen and the USD has weakened.

At the time of writing the S&P 500 has recouped all its losses for the year, having climbed around 34% from its low on 9th March. To many this has sent a bullish signal about the path of the economy ahead given the historical lag of around 5 to 6-months between equity gains and economic recovery but to others include myself this is sending a false signal. Even if the economy stabilizes any recovery is likely to be slow.

As stocks have risen, cautiousness about the current rally has intensified, with many now calling for equities to correct lower. This could partly reflect sour grapes from those investors who have missed the move in equities (I like to think that I am not in this camp even if I did miss the move) but there is also an element of truth in terms of equity market valuations, which have risen sharply over recent weeks. Although arguing whether stocks are cheap or expensive depends on what measures are used there is even some caution coming from equity bulls.

Bloomberg estimates one measure of equity valuation, the Price / Earnings ratio of the S&P 500 at 14.78, which is still below the estimated P/E ratio of 15.96 but much higher than the P/E ratio of around 10 at the beginning of March. Other estimates also suggest that the current P/E ratio on the S&P 500 is approaching a long run average, which suggests that further upside for equities may be more difficult in the weeks ahead.

What now? So far markets have reacted to the fact that economic conditions are the past the worst and the reaction has reflected less negative economic data releases, with many data releases coming in ahead of expectations. Going forward, it will require actual positive news as opposed to less negative news to keep the momentum going. If positive news is lacking the improvement in risk appetite and equity market rally will falter, especially as valuations are arguably far less compelling now.

I would be interested in your view about whether you think the rally will continue. Please tick the the relevant circle in poll on the sidebar to give your view and also view what others are thinking.

Posted in bank rescue, Bond markets, Commodities, Currencies, Economics, equity markets, Financial crisis, US, US administration. Tags: , , , , , , , , , , , , . 5 Comments »

Anxiety over Swine flu

April 29, 2009 — Mitul Kotecha

Although I have been writing about various factors that could derail the rally in equity markets and improvement in risk appetite over recent weeks I did not envisage that a virus such as Swine flu would be one of the factors to consider. However, it is and the stress and anxiety about its effects on the economy and of course health are rising rapidly.

In Hong Kong where I have been based for the last 8 months the concerns are particularly acute. Exposed from a high proportion of tourism as a percent of GDP, high population density and its importance as an air travel hub, Hong Kong is somewhat more sensitive than many other countries. Moreover, the memories of SARS and its devastating impact on the economy still linger for many people. A local paper revealed such tensions in its headline, “its creeping closer”

Nonetheless, there is little in terms of concrete evidence to go on and outside of Mexico the health impact of the virus has not been as severe. Even in Mexico there have been conflicting reports about the actual amount of deaths, with some putting it at a much smaller number. Until there is some clarity markets will continue to react to the uncertainty. The rapid spread of the flu has sparked fears of a global pandemic but it has yet to be categorized as such.

Risk indicators have not yet reacted sharply even if equity markets have been hit over recent days, suggesting that at the least there is not a panic in markets. Even the usual FX beneficiaries of higher risk aversion such as the US dollar and Japanese yen have not strengthened and remain in a broad range. It is difficult to predict the damage from the flu and much depends on its severity and how much it spreads but the relative calm in the market is at least encouraging for now.

Posted in Asia, Currencies, Economics, equity markets. Tags: , , , , , , . Leave a Comment »

Q1 earnings in focus

April 10, 2009 — Mitul Kotecha

Equity markets have continued their ascent albeit with continuing volatility around the Q1 earnings season. Other indicators of market stress have also improved whilst bond yields haved edged higher. Next week will test the markets optimism with a plethora of banks set to release their results for the past quarter. Wells Fargo provided a boost to financials today with its earnings report. Banks will benefit from the changes to mark to market accounting regulations allowing banks more flexibility in valuing their dodgy assets. Although I am somewhat concerned about the political push for the change in these accounting rules it will no doubt ease some of the pressure on banks and their estimates of writedowns.

Meanwhile the economic news continues to be less negative as the bigger than expected narrowing in the US trade deficit reveals. This adds to the run of better than expected numbers over recent weeks that is perhaps showing that the pace of economic deterioration globally is easing. The economic news has also contributed to the better tone to equities and improvement in risk appetite.

Action to prevent the economic and financial crisis from deepening is also creating a floor under markets. The Bank of England left interest rates unchanged but maintained its commitment to conduct asset purchases having done around 1/3 of the planned GBP 75 billion so far, with the remainder to be undertaken over the next couple of months. Elsewhere Japan will provide further fiscal stimulus to boost its flagging economy although the unstable political situation could yet derail such plans. Nonetheless, the picture is clear as policy makers continue their battle to boost sentiment and thaw credit markets.

If markets can get through Q1 earnings without a major set back there maybe hope that the rally really has got legs. I still think there is a whiff of a bear market rally going on but I would happy to be proved wrong.

Posted in Bond markets, central banks, Currencies, Economics, equity markets, Financial crisis, UK, US. Tags: , , , , , , . 1 Comment »
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