Headlines Today

– Stock markets globally fell today as the Greek crisis showed no signs of abatement and with Euro zone leaders and IMF dragging their feet on the rescue package
– – Greek package announced, its upward of USD 120 billion and puts stiff conditions on Greece which it has agreed
– – Markets worldwide fall despite the Greece package as the risk of the contagion spreading to other PIGS countries grows
– Markets globally fall due to overheating fears in China as the first quarter GDP rises over 11%, nearly 3% points higher than the governments target
– Chinese Purchasing Managers Index (PMS) falls to a six month low and markets globally fall due to fears to China’s growth slowing down
– Consumer Consumption, factory orders, results etc. etc are all better than expectations in the US. Cash pile with US corporates grows to near all time highs.

I mean give us a break. What is the real concern, why the markets falling and what are is the way forward? I believe that there are several factors at work today and all of them have to be combined together and their magnitude gained to make any meaningful long term assessment away from the reaction to daily news flows.

PIGS – To analyze what is likely to happen in Greece it is important for us to go back to the crisis of some of the other crises of similar kinds in history. Without going into the details for the sake of brevity two of them were the South East Asian crisis of the late 1990’s and the Argentinean crisis of early 2000’s. These crises were both different as well as similar to what is happening in Greece today and the most important similarity is the amounts owned to overseas lenders. Today 10 years down the line both these crises have passed and no country has gone down. The reality finally is that countries finally do not go down like companies. As such correlating what happened to Lehman or Bear Stearns to what is happening to Sovereign countries is not right in my view. Moreover there have been so many instances in the past where countries have bounced back from high debt to GDP ratios. However for this there has to be a realization that there is a real problem and that it needs to be addressed. Also as per my understanding of the other economies which are combined in the PIGS grouping the problems are not as great with the deficits of all other countries being below 10% of GDP and debt to GDP lower than 90%. The only thing that Greece cannot do which happened in the case of the South East Asian crisis is that it cannot devalue its currency to move out of the crisis as it is part of the Euro zone. Although the Euro has fallen sharply over the last few months, the fall largely benefits big exporters like Germany and not the countries in crisis. If Greece was an independent economy then actually the German currency would have appreciated and the Greek currency would have fallen and thus improved terms of trade for Greece which is not happening today.
The other important thing is that Greece as an economy is a very small part of the global economy and as such its long term impact is likely to be very small।

China – What is the real concern about China, is it the overheating or the slow down. I believe that the kind of indiscriminate lending that has happened in that country combined with the artificial export competitiveness built in by keeping its currency severely undervalued is a bigger risk today. Till two to three years back China was competitive in exports by itself as its exports remained strong despite the country allowing a Yuan appreciation and despite a huge increase in labor costs. However today when the currencies of most emerging economies of any large size like India, Korea, Brazil etc have appreciated by nearly 15-20% (if not more) since the time of the crisis vis a vis the USD the Chinese currency continues to be pegged at artificially low levels. It is estimated that the Yuan is undervalued by at least 30%. Despite this undervaluation China had a trade deficit of USD 7.2 billion in March. This combined with the huge credit growth as well as large scale borrowing and spending by provincial governments in China is creating both a money bubble plus a potentially damaging increase in Non Performing Assets for banks in China. Property prices in China have risen to record levels and are still rising. The infrastructural development has been happening with no returns in mind. There are clear signs of an asset bubble being formed. The good part is that the Governments fiscal position as well as household savings continues to be very healthy. Typically the kind of overheating we are seeing in China is something that is very difficult to control. All of us need to hope that they will be able to engineer a soft landing as the risks of a hard landing in that country are growing. The best scenario for us in India is a slowdown of Chinese growth to a 6-8% range. This will reduce pressure on commodity price rises and will also not be a crash which will have worldwide implications. Eventually a Chinese slowdown will be beneficial for us as it will reduce inflationary pressures.
The other factor which has impacted the markets has been the strength of the US Dollar index, again mainly due to the weakness of the Euro & Yen। The USD looks extremely overbought at this stage and should see some correction over the next few weeks. My technical target was a level of 83 which actually got breached yesterday.
On the other had the economic numbers and corporate profit numbers coming out worldwide have been very positive and indicating clear signs of recovery gaining steam. Specifically in India the results season has been progressing well and growth outlook across industries is picking up. The same is the case in results across other emerging and developed economies. Growth in India looks sustainable with consumption growth likely to remain strong due to improving earnings, increasing employment as well as easy credit availability. Investment growth is likely to be driven by infrastructure investments as well as first signs of corporate sector capex revival. The year 2010-11 is looking to be a 9% kind of GDP growth year with corporate profit growth of 25%.
I do not see markets correcting sharply from where they have reached over the last few days. Improving economic growth numbers combined with the investor psychology which is still skeptical of the rally in the markets will support the markets. No excessive speculation or leverage has being built into the system which will lead to any sort of crash at this stage. The worst case seems to be a further 3-5% downside.
The current correction could be the last major opportunity for investment into the markets which should target new highs over the latter part of the year.

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