Half a month into the New Year, what’s up?

The New Year has started off on a positive note both locally and globally with most markets etching up moderate gains since the beginning of the year.

In the global context the two most important geographies from a sentiment point of view continue to be the Euro zone and the US. Key events in Euro zone have been the continued rally in peripheral bonds and the strong bond issuances by countries like Spainand Italyat yields that are much below earlier levels. These two counties now have raised nearly 10% of their total funding requirement for the year in the first half of January itself. The more important thing is the participation of foreigners in these auctions as the last 15 year bond auction of Italy that took place a couple of days having a 60% foreign takeout. The other important development in Euro zone was the ECB meeting and the surprising outcome where the ECB did not cut the policy rates despite expectations for the same and his belief that there will be some sort of recovery in Euro zone in the second half of the year. Given the credibility that Draghi has built up since his statement of “To do what it takes” this immediately led to a rally in the Euro. In midst of the currency wars underway the broad non participation of EU in the entire phenomenon should lead to a broad based strengthening of the Euro over the next few weeks and months. From the EU perspective, the importance of attracting capital flows to fund the huge bond offerings from various countries will continue to be a more important factor rather than the stimulus created by  a depreciating currency.

As was expected and as I pointed out in my Annual Newsletter the Japanese Yen has fallen sharply given the rhetoric around the same by the Japanese. The long term appreciating trend of the Yen seems to have clearly reversed and the falling yen has created a strong rally in the Japanese Equity markets. From a global perspective higher Japanese stimulus and a falling Yen should again restart the dormant Yen carry trade in a big way this year. However, whether it can lead to a 2% inflation and a revival in the Japanese economy will need to be seen. Given Japanese demographics and the per capita income levels, any major revival in economic growth looks unlikely. Also it is important to analyze whether a higher inflation is actually beneficial for them given the average age of the population and the number of retired people.

The drama in the USwith regards to their self imposed Debt Ceiling continues and once again, in all probability we will see a last minute deal. The trends in the US economy on the other side seem to be of steady improvement despite the uncertainties created by the last minute Fiscal Cliff deal and the wrangling on the Debt Ceiling limit. This seems to show underlying strength in the economy. The revival in the housing sector and also the pick up in home prices should further add to positive sentiments going ahead. Overall things look positive from a USstandpoint given the fact that despite increasing Debt to GDP the average cost of Debt has been continuously falling and as such the burden of interest payments should not grow much, if at all in the near term. What we need to see is the extent of spending cuts implemented and the follow through drag on economic growth. This should be clearer by the second quarter.

The Indian markets started the year on a positive note backed by strong foreign fund inflows which are already touching Rs 10,000 Cr for the year. Further economically prudent decision making by the government has aided sentiments. Talks of further action on subsidies and the hike in railway passenger fares have been taken positively. The continued assertion by the Finance Minister about meeting the Fiscal Deficit target combined with lower expected borrowings created a strong rally in the bond markets as I had pointed out in my Annual Newsletter. The rally has got interrupted lately due to comments by the RBI governor about inflation still being high (although inflation is now at a 3 year low). I really don’t know where he gets his facts from as the economy has come to a standstill on the interest rate sensitive sectors and manufacturing inflation has fallen to 4%. I do not think that we can have zero inflation in a country like India and as such what they are targeting seems to be uncertain. The monetary policy stance is not helping the economy in anyway except for keeping the growth rate far below potential.

The postponement of GAAR by three years is also a big positive which should lead to greater funds flow into the country over the next year. Partial diesel deregulation announced today also is a big positive. However its implementation will need to be seen.

Given positive moves by the government on oil subsidies as well as other economic decisions the case for RBI not coming out and supporting growth in a big way is just not there now. Let’s hope they see sense.

Results season has started with a bang with all IT companies reporting very strong results and some of the Private Sector banks that have reported also reporting strong numbers with good asset quality. As such the results season should be supportive of the markets.