I don't know whats' scarier, that so much has happened to the markets in just a couple of days OR that this happens so frequently. This post looks like its gonna be a long one...so I'll start with listing down the dots, and then spend some time connecting them...followed by some philosophical discussion ;). Stay with me on this one, for its gonna have some links to very good documents and other blog-posts as well.
Some of my select picks among many data points:
- China Market tumble 5% on Interest Rate Increase:
The People's Bank of China increased its lending interest rates by 25 basis points (0.25%) to 5.56% - its first increase since 2007. The central bank is expected to follow suit this week-end or early next week. This is apparently being done to rein in inflation which is a major cause of concern in China. China has obviously timed it to offset dollars flowing in from the QE II release, and there are talks of another rate increase before the end of this year. Markets see this as a dampener to growth, and future investments in the markets so the markets tanked over 5%, its single biggest loss since Aug 2009. A snippet of what went on in the Chinese markets on 12th Nov (courtesy: Bloomberg)
- Commodity Markets tumble:
Crude Oil, Sugar, Soybeans, Corn fell sharply on news of interest rate hike from China. The markets are expecting a slow-down in demand of various commodities due to increase in interest rates (interest rates are usually increased to rein in inflation, as people save more (to earn more interest) and spend less - thus this kind of move takes away free-money from the system, clamping demand and thus reducing inflation). If you would like to read more about this, read it on Mish's blog - here. As per LA Times, sugar fell 11%, gold 2.7%, copper 3.2%, and soybeans 5%.
- Ireland's debt crisis spooks investors:
The PIGS (Portugal, Ireland, Greece and Spain) are back in news. Apparently, investors are getting worried about Ireland's ability to repay its debt, and mirroring this sentiment are the bond markets worldwide, which sent the Irish bonds prices tumbling resulting in difference in yields between the Ireland and German 5-year bonds to a record 6.6% (yields on bonds increase when bond prices go down - which they do in such times when sovereign rating suffers (country doesn't seem to have money to repay its debt) or if prospects of interest rates reduction in future are higher - more on this in some other post). But EU was quick to come out with some reassurances (here - a post by Calculated Risk) which calmed the markets down to some extent. Read a good article on this from WSJ here.
However, this news did cause quite some worry to global investors who pulled out their money from equity and commodity markets - not really because Ireland is a large economy but due primarily to the fear of contagion effect, i.e. If Ireland defaults, Portugal and Greece might get in a worse condition than they are now (since they hold substantial amounts of bonds from Ireland) and if they too default, so will Spain, and then so will France and Germany - the two biggest countries in the EU...and then down goes Euro - triggering a global currency crisis. (I know it seems like a doom's day scenario, but if markets are taking these thoughts into consideration, its scary to sense how close we might be to this turning into a reality). [Another good post for further reading by Mish here]
- Euro falls against Dollar, then pulls back some:
Spooked by the Ireland debt crisis, the Euro fell sharply against dollar but recovered a bit after the regulators made some reassuring statements. If the focus again moves towards evaluating the sustainability of the Euro-zone as a region, and Euro as a sustainable currency, dollar may not fall against other currencies as was widely believed post QE II (that's a release of USD 600 billion by US Federal Reserve into the banking and financial system to spur markets and growth).
Now, the essence of the above picks is that there is no single path post QE II - this path was thought to be something like this:
Fed Releases Money (QE II - USD 600 bn) ----> US doesn't have fundamental to absorb this cash ----> Money finds its way into other markets (China, India, Brazil, Russia, Korea, Singapore, etc.) and other asset classes (real estate, commodities) (as a result of all this dollar selling and buying of local currencies, the latter goes up against the former) ----> Markets worldwide move up, so does Gold ----> Inflation (as imported by US) increases in world markets ---->US starts exporting more to feed that growth (as with depreciated dollar, US goods become cheaper; also, US interest payments (huge now, even bigger in future with a strong dollar) feel lighter for the government)----> US economy recovers due to jobs returning, fueling demand ----> World markets increase interest rates to rein inflation ----> Markets tank ----> Dollar moves out ----> Local Currency appreciates ---> Exports pick up ----> Economy picks up....
Now, that's more or less the holy grail of the markets, and economics.
What has instead happened (from the little data unraveled so far), is that the cycle has skipped some middle steps ...
Fed Releases Money (QE II - USD 600 bn) ----> Fearing inflation and asset bubbles, China increases interest rates to rein potential / future inflation (a precautionary measure)----> Markets tank ----> ....???
Just like life, markets too are in a hurry to catch up with the end...but all said, this puts a big question mark over how things are going to unravel post QE II. An excellent post by Mish (again) on this here.
And with this, the age-old questions are here to haunt us again - Is this the end of the beginning or the beginning of the end? Have we topped out on markets? On Gold? Should we completely get out? But stay in cash ? Which Currency?
My take is, (atleast for Indian markets) hang-on...we have good supports coming up a little further down from here...domestic demand is still intact...asset bubbles (real estate, indices) aren't of enormous proportions as in other countries...Inflation is a concern but regulator is taking measures occasionally to rein it in, Gold - well, a good hedge for its strong fundamental factors is a possible depreciation of dollar against INR. We'll have to be cautious, alert, nimble...as things pan out better in the open.
Till now, the normal approach was seen as US Fed release money ---> US markets improve ----> US Economy recovers....(as expected by the US Fed)...
And the contrarian approach was that this will not happen....instead the dollar will depreciate, US will not benefit from releasing money, other countries will...and so on.
But with the developments in the markets during the last couple of days, the contrarian approach really seems that Gold will go down, emerging markets will go down, dollar will appreciate against most other currencies, etc.
At the end of it, the funny thing with taking a contrarian approach is, if you're taking a contrarian approach without knowing how many contrarians are there in the market, and if there are too many contrarians in the market, which one is the contrarian approach, really?
Think about it...I will...!
Leaving you with some food for your thoughts...
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