Since I wrote ?The coming equity crash? (Financial Express, May 27) the Indian equity market has, well, crashed. This has been a global phenomenon, though India has been up there with the biggest losers. The question today is when will the bear market end? In the earlier piece, I recalled that 300-year old City of London adage, ?Sell in May and go away; don?t come back till St Leger?s Day?. St Leger?s feast day is October 2, though those canny old stockbrokers in the City were probably thinking less about Saints and more about the horseracing calendar. The St Ledger?s Day meet in Doncaster, England, is around September 9. This seems to be a reasonable time-frame but I have never held much stock for superstition or repetition. The question is what force is driving the markets lower?globally?and when will these forces be spent, reverse or face a countervailing force.
I argued back in May that global markets had to go through a conversion from thinking that if things got really bad that the central banks would be there to help them out with easier monetary policy, to thinking that the central banks are not there anymore?because of the inflation threat?or at least that they are only partially there. I argued that this conversion in market thinking, required before a recovery could take hold, would probably be associated with significantly lower equity valuations and a turn in the dollar as the stance of Fed policy changes. Well, since May, a number of countries have raised interest rates despite the uncertainty in global activity?including India?the dollar has not plumbed fresh lows and equity markets have fallen far. In the words of kids in the backseats during a long car journey, ?are we there yet??
Perhaps. My instinct, though, is no, not yet. I am not sure the markets have yet to discount the full scale of economic weakness to come from the developed world. The prevailing view is still optimistic. It is that there will be a modest slowdown this year from the headwinds of the credit contraction, that this slowdown will cap inflation and with inflation better behaved, central banks will be able to come to the rescue of economies later in the year, helping to fuel a recovery early next year. Instead, what we are seeing are the second-round effects of the credit contraction and rising inflation expectations.
The world?s largest banks are no longer posting losses just for their exposure to sub-prime mortgages, but also for their exposure to other loans. Auto loans are coming under much scrutiny. The US and Europe are caught in an inevitable down cycle. Credit contraction is leading to a contraction of economic activity, which is leading to the fear of job losses which is leading to lower spending, more economic weakness and so on.
The free-fall in house prices in the US and Europe is also making people feel less wealthy and leading to a rise in the savings rate. We must expect that a slowdown in spending in the US leads to a global slowdown. The US cannot be the ?consumer of last resort? for the better part of a decade, propelling global growth upwards and its own current account position downwards, without there being global repercussions when it switches from spending to saving.
My bearishness should not be seen as reason to abandon markets altogether. There is value to be found in the financial markets even when the overall indices are weakening. That is not to say you can consistently make positive returns when all else are losing 25-35%, but you can lose less than others and be better positioned for the next phase in the market. Clearly in a credit contraction you have to favour the stock of those companies that are not burdened with short-term debt or exposed to consumer discretionary sectors.
From an Indian perspective, favour domestic to external consumption. But also look for value in those sectors that have been beaten up most. Fear will lead valuations to overshoot on the downside. If you don?t have to worry about market-to-market valuations there is now much value in credit instruments. Look at the yield on preference shares or corporate bonds where there is healthy cover for interest and dividends. The energy sector has fared well over the past three years and it is tempting to chase those returns, but I would be underweight a sector that is clearly in a bubble. Underweight?but do not abandon altogether, bubbles can last a long time. Be wary also of too much exposure to those regions dependent on that bubble continuing to be pumped up such as the Middle-East and Latin America. Good luck.
?Avinash D Persaud is chairman of Intelligence Capital Ltd, a financial advisory firm, and emeritus professor of Gresham College
