The year 2015 has marked the return of volatility to the financial markets. We have seen huge moves in the foreign exchange and bond markets in response to the European Central Bank’s Quantitative Easing program, the “Grexit” debate, the surprise move by the Swiss National Bank to abandon the Franc’s peg against the Euro and energy prices have been driving the risk on/risk off sentiment.
Most importantly, the US Federal Reserve is going to raise interest rates some time later this year, but the market doesn’t seem to believe so. The US 10 year yield is at 2.1 percent as compared to 2.7 percent the same time last year. There is a huge mismatch between what market participants believe and the path the US central bank seems it’s on. In this backdrop, Indian equities are trading near lifetime highs, not having lost their faith in Prime Minister Narendra Modi and his government.
Vatsal Srivastava spoke to Shankar Sharma, vice chairman and joint managing director of First Global financial consultancy, for his expectations from the upcoming budget and other economic issues – as also to get his thoughts on the current global macro trends. Sharma is one of Dalal Street’s most respected voices and, more importantly, a man who has proved very accurate in calling major turns and inflection points in the markets over the years.
Q: What are the top three items on your wish list for this budget? If Finance Minister Arun Jaitley disappoints, do you see a deep correction in equities?
A: I see a deep correction post-budget, irrespective of whether it is good or bad. Budgets never determine directions of markets 90 percent of the time. In any case, I never put much attention to budgets: every finance minister presents what he thinks is a dream budget. The dream, unfortunately, ends the moment the budget speech stops. The nightmare begins the moment you start reading the fine print.
Q: The Nifty is at 8,800. Clearly, lower crude prices and a global equity rally have also helped maintain the uptrend. What policy changes by newly formed BJP government (if any) have fuelled this bull-run? With global yields at record lows, where do you see the Indian interest rates in 2-3 years?
A: My view on India is simple: Our 10-year bond yields are too high, at 7.7 percent. Given that bust countries with falling currencies across the Euro zone have 10 year yields at 0.5 to 1.2 percent, I see no reason why India should be paying 8 percent on its long-term bonds. In my view, yields in India will collapse to 4-5 percent in two years’ time (we saw these levels in 2004). Markets will automatically go up because of this one reason. Markets will not go up because of any policies or the like. Those are red herrings.
In my view, stock markets across the world have simply become a monetary phenomenon. Government policy doesn’t matter any more. What matters is only how low the cost of capital becomes so that your discount rate with which you price growth falls. Then, even moderate growth ends up looking very good in Net Present Value (NPV) terms, simply because of massive declines in hurdle rates. So if you have 15 percent growth and the cost of capital is 12 percent versus 10 percent growth with cost of capital at four percent, you will have greater NPV in the slower growth scenario!
That’s precisely what’s been happening across the world. Good countries, bad countries, all have seen huge bull markets. This is a bizarre world, but it is what it is. Hence, I am bullish on India for one simple reason: I see cost of capital in India falling sharply as inflation goes to zero or negative, (thanks to oil prices), and bond yields crash. I am not bullish because I expect any miracles to happen on the economic front: in a world stuck in low growth, for India to grow at eight-nine percent can only be achieved by manipulating economic data. Which, by the way, we just did!
Q: The Indian rupee has held its ground over the last many months even on the back of a broad greenback rally. Can we expect this trend to continue?
The rupee actually has been a lot weaker than its fundamentals suggest: it has fallen from 58 to 62 since May 2014. That’s not called holding its own. Only when you compare it to the real, the yen, or the euro, you could say it’s been better. But it has still fallen a lot more than is merited purely on fundamentals. We have oil at $50 and the current account is flat – and yet, the rupee has fallen. The (Philippine) peso and the baht have done a lot better. I see the rupee falling to 64-65 or so this year.
Q: Globally DM (debt market) equities are near their all time highs primarily due to a dovish US Fed and QE from Europe and Japan. Do you see a real economy recovery anytime soon-especially with regards to the Euro-zone and Japan?
A: Japan is a tad better than the Euro-zone, but only because it has spent longer in recession! I remain very bearish on the outlook for growth revival almost everywhere in the world, let alone in Europe and Japan. The US growth is illusory, pumped by the boom in fracking. Job growth and economic growth both have been largely contributed by the US Oil economy. In many ways, the US is like any pure Oil-dependent economy. What impact will $50 oil have on the US is not hard to imagine. That’s why there is so much unhappiness in the US over the state of the economy. It has been a very segmented revival, largely shale driven. As regards UK and Europe, I see plenty of slow growth ahead, the same as what we have seen since 2008. Years of living beyond your means can’t be corrected in just five-seven years.
Q: If not, how long can this party continue?
Q: There is no party. The party has been on only for a narrow list of people-fund managers, hedge funds, private equity and company promoters. The average guy on the street, anywhere in the world has been living a hellish life since 2008: no jobs, no growth, no hikes, no fun. There is just so much discontent in the world. Why would this be the case if stock markets were the sole barometer of how happy people are. Truth is, inequality has widened vastly since 2008, and I see no let up. Central banks have decided that the only guys who matter are people with money,who play markets for a living, so let’s keep an elitist party going. That said, I am very clear that even this scandalous, elitist party is fast running out of free booze, and will now crash out this year itself.
Q: In your view, when will (Fed chief) Janet Yellen hike interest rates? Where do see the Dollar Index in two years?
A: Looks like Yellen will raise in Q3 of this year. Whether it’s the right move, I am not convinced. I don’t see inflation as threat. I am very bullish on the USD and see it well past 100-105 in the next 2 years, largely because of a collapse in the Euro and the GBP.
Q: What is your view on oil and commodities in general? We have had some headlines of oil rigs shutting down in the US over the past few weeks. Can oil sustain at these levels or are we in for reversal?
A: I have been bearish on oil and on all commodities in general for many years now. Commodities can never have sustained bull markets. The world will always find ways to kill a commodity bull market because this is the only bull market that impoverishes most of the world. All other bull markets be it equities, bonds, real estate, create widespread wealth. Given this, I see only chance of any sustained revival in oil, save for technical bounces.
(Vatsal Srivastava is consulting editor for currencies and commodities. The views expressed are personal.)