Uncertainity is the new trend

I spent quite some time thinking up the title for this post, 'coz the points I'm about to cover in this post are neither bullish nor bearish...and it all rolls-up so differently for different countries, despite being ever more interconnected with each other. Its' like playing a game of chess, but with 10 boards kept beside each other, with the possibility of moving pieces of one board to the other...imagine the possibilities...the inter-connections...the complexity of the game...

Something similar is at play here, and like I've said in my earlier posts as well, the players are central bankers and governments more than the usual market players...who'll decide which way the game goes.

How would you like your Markets - Shaken or Stirred?

Ok, this post isn't about connecting Markets and Bond, though Casino Royale did attempt that...Its about re-looking at major factors that can move the markets from here in either of the 3 directions (sideways is also a direction ;)).

Post QE II (where US released some USD 600 bn to induce growth into the system), everyone and their pets were bullish on the emerging markets and inflation in some pockets thereof. However, Chinese counter measures for preventing money flowing in freely into their system, combined with the Europe crisis, has clearly shown the world the other side of the coin. Where do we go from here, is a question people have started asking again now.

So I thought I'll compile a list of global and domestic (India centric) factors that can affect the markets significantly in either direction:

• European Crisis: 

Although Ireland has agreed to the bailout by IMF, Portugal and Spain have already started to look bad if we take cues from the bond markets. Ireland story is not done yet though; it looks like they got the raw end of the deal - IMF has gotten them to agree on spending their Pension Funds first (for repaying their debt which is coming due soon) and only after that they should touch the 1st dollar (or Euro) given by IMF. What this implies is by the time Ireland gets to spend IMF money, they are already bankrupt...and hence completely dependent for quite some time on IMF. Irish are not very happy with this...protests will happen, heads will topple, and may be, just may be, terms and conditions will be re-looked into.

Portugal is not as big an issue as Spain - given the massive difference between the size of their economies. Its like saying I have a tooth-ache...may be a tooth has gone bad and needs to be pulled out...and o yes...I have brain tumor too...but thats not aching so much...!

Spain is a bigger problem than Portugal, and this time around, the markets are not waiting for crisis to come up before it tanks again. Money is flowing out of Europe. And to top it all, there are some bank runs being planned as well (No, I'm not kidding!). December 7 is being planned as the day when civilians across Europe are getting together to take out all their deposits from various bank accounts...(read this article from Zero Hedge). That means banks had better spruce up their cash levels to meet sudden surge in requirements, and if they don't...well, we'll know which banks were naked behind the curtains ! Can't say how much support is there for this cause, but it's been on for quite some time now. [As an aside, Wikileaks has said that early next year, they're going to do a big leak on a major US Based bank...read here. So if we miss solid action on banks in Europe on Dec 7th, we can still look forward to action from US banking circles early next year.]

• Inflation:

India and China are reeling under severe inflation...(while US is praying it'll have some of it !) and are unable despite all their efforts to bring it down. They are also growing at a scorching pace...India has grown @ 8.9% last quarter as compared to 8.2% in the same quarter last year. Indirectly, the growth and inflation impact is even causing intermittent cash crunch in call-money markets in India (these are short term borrowing markets, in which companies borrow for 1-3 days to tide over their working capital gaps). In fact, RBI has recently made some temporary changes to CRR to infuse more liquidity in the market to cool down the lending rates in call-money market. Too much of inflation and uncontrolled growth always poses a risk of a hard landing...bringing in crash scenarios for markets to consider. If these scenarios persist, RBI is quite likely to raise interest rates / suck out liquidity from medium term perspective (especially by clamping down on lending to Real estate sector), which will further push the markets down (though not lead to a crash).

• Currencies

Dollar is clearly appreciating against all major currencies...very unlike what was envisaged just some time back. Euro is retreating...and no big support will come in till clarity comes in on the extent of crisis in the rest of Euro zone. China, Russia, Brazil, some other SE Asian markets have started trading in their local / preferred currencies apart from Dollar, as "Dollar is better than Euro" is not being seen as a convincing argument by markets. India is not a major market in the world, in fact, it is not even a significant part of the portfolio for many major funds, who, anticipating more scams, hard landing, might take money out of the markets, pushing rupee further down. Export lobbyists wont complain though. But its not that all's well for dollar from here, as soon as Europe crisis is played out / contained, dollar too will take a hit, 'coz fundamentals of US economy are not exactly confidence boosters.

• Interest Rates, Growth cooling

Interest rates are very likely to continue hardening in China and India, both to cool down inflation, contain growth, and avoid adverse effects of QE II money flowing in. Meanwhile, other SE Asian economies - Singapore, Thailand, Indonesia, Malaysia, are too cooling off. And "Japanese economic growth" has long been accepted as an Oxymoronic term, like Military Intelligence - the words exist separately, but sewn together, mean nothing. Every time high-growth economies like China increase their interest rates (there is already talk about another increase, after the recent one), commodity prices are going to take a huge hit, and so are equity markets (partially due to contagion effect, and partially due to prospects of reduced growth). A lot really depends on how central banks act at this stage...the question is no longer whether, rather how much, and when.

There are some other such factors, but I believe these are the ones with most far-reaching consequences. So while most of the factors are pointing towards a gloomy scenario, its still too early to write off the bullish scenario for the markets that we had envisaged earlier. It all really depends on how each of the above factors plays out...and how well or badly the central banks tread the thin line between inflation and growth. US too is not out of the woods yet...it just keeps postponing its problems, right from contingent liabilities of social security to medical expenses, from unemployment to huge fiscal deficit...

The time is running out for Europe, US,...at some point of time, something's gotta give...just then we'll know really how decoupled we are from the developed world...till then...stay tuned to the markets, and never forget to take cues from the Bond markets - for its him who'll tell whether the markets will be served shaken or stirred.

Wrap Up - Scams, Markets, Bonds, Currencies

I was on a 4-day vacation, so could not post anything, but managed to keep in touch with the latest happenings. So much has happened that I think I'll have to skip a few topics - mostly related to Scams...but a quick word on those nevertheless:

Medianama has given some really interesting links (HT: Deepak Shenoy - Capital Mind) to audio files and transcripts of conversations between Niira Radia and several prominent personalities like Ratan Tata, Ambanis, A Raja, Barkha Dutt, Vir Sanghvi, etc. Fairly interesting read / listen, depending on how much you like to hear the now famous "All India Radia" ;)

And now, back to the markets - Ireland has finally accepted the $ 113 bn EU bailout package with severe austerity measures, which is obviously not going down well with the civilian rights groups...markets are not impressed, the Dow is down over 1% at the time of writing, and the focus has now shifted to Spain and Portugal (yes, already !) The Spanish 10-year bond yields rose 0.14% to 5.35% and that of Portugal rose 0.09% to 7.23%. Bond yields increasing means bond prices are going down - markets, expecting higher risk of default, are willing to pay lesser for a "secure" government bond. This will typically hit the Mark to Market (M2M) of treasuries of banks and central banks who are large holders of these bonds - for them, the value of a prime part of their portfolio just went down...who may then be needed to set aside some more capital to make up for the losses...for which they sell some other country's bonds...and so goes the contagion.

As an aside, the yields on 10-year US Treasuries is approx. 2.83% and that of India's is around 8.03%...so technically, India is far more likely to default than Spain / Portugal...but unlike these countries, India still has the power to print its own currency (INR) and pay back the debt in the worst case scenario (although that would trigger hyperinflation here, but thats a separate story altogether).

Meanwhile, after a brief respite during the Ireland bailout talks, Euro continues to slide against the dollar. Here is a quick recap of the last 1 month's euro-usd movement:

(Chart: Courtesy Yahoo! Finance - Click for a larger image)

It reinforces the fact that market players are not yet completely done with Europe with Ireland bailout news...they would like to get a sense of where it all is going before coming back into the markets - in the meanwhile, they'll keep selling stocks and taking money out of European markets...leading to slide in both - European markets and euros.

Similarly, INR has also weakened against the dollar considerably over the last few days...a glance here as well:

A similar logic here as well, though default is not the top-of-the-mind topics for India, one scam after the other is rocking the markets, resulting in a few exits as well. Both euro and rupee have hit a 2-month low...can't really say how much lower they can go from here.

But to me, overall markets look good to go up from here...am still going with what I've said in my earlier posts...but beware of Bank Nifty, banking stocks, and of course, realty...

Indian Companies raising International debt

This is another trend that’s catching up…more and more Indian companies are going abroad to raise debt. 

[Note: Here, I’m attempting to just introduce this topic for arousing general interest, without getting much into the details, as I understand my readers may not be as well versed with the debt market dynamics as with the equity market. Over a period of time, I intend to introduce more in-depth and well-researched articles on debt markets –  nevertheless, it's important to understand this to really understand the overall economy dynamics and even the equity markets !]

What is the International Debt Scenario ?

Just in this year alone, Indian companies have raised USD 10 bn of funds through sale of bonds…this figure is higher than the last 8 year put together !

Recently, after a gap of almost 13 years, Reliance (RIL) raised a debt of USD 1.5 bn internationally. Till date, ICICI Bank was the most active Indian corporate entity on this circuit, but off-late others have also decided to jump on the band-wagon. Axis Bank, SBI, IOC, Essar Energy, JSW Steel, GMR, Reliance Communications, IDBI Bank, Rural Electrification Corporation (REC), etc. are just some of the names who have either recently raised, or have concrete plans to raise international debt shortly.

Why raise debt?

If you are in need for funds (for expansion / acquisition / any other purpose), there are two ways of raising capital – either issue equity (sell stake to a Private Equity player / Strategic Investor OR issue an IPO / FPO and raise money through normal capital market route from retail investors) OR raise debt. Now, the big differentiator between equity and debt is, equity is tomorrow’s money, debt is today. Someone who is parting with equity to raise funds is parting with returns from future growth, while someone who is raising debt, believes the returns on debt will be good enough to pay the interest and still enhance overall shareholder value / enterprise valuation.

Why International debt?

This is an easy one…the interest rates outside India are much lower than that in India, so its cheaper to raise money outside, and pay, say, 7% interest per annum, rather than raise the debt in India and pay, say, 12% interest per annum. For example, a whole lost of money that Reliance is recently raised, will be used to retire the more costly debt, resulting in direct savings in quarterly interest payments and therefore, higher PBT (Profit Before Tax) – a figure that’s closely watched by all investors in the market during every quarterly result release.

Global Perspective

While its heartening to know that Indian corporates are reaching out internationally, but we’re still nowhere close as compared to our smaller peers…for example, this year India has seen some 12 international bond issues, while Korea has already done 69 ! For India to reach even that level, several things have to go right starting with improvement in India’s rating (and image) in the Global markets, enabling Indian corporates can raise debt at even lower rates. The bond offerings have to be more frequent so that its worth the while for bond portfolio managers to track India and some top Indian companies. Besides, the offerings have to be bigger in size – nobody’s going to track a whole economy or an industry and a company within that industry for a total bond offering sizing up to 100 mn dollars…besides, as the debt offering increases in size, the cost of raising that debt comes down proportionately (to some extent – I know I might be wrong here simply due to over-simplification).

You might want to go through this dated 2007 article briefing how bankers told companies not to go for international debt sales then ! 

And Finally, so what?

There are a lot of takeaways for the lay investor in this information itself…

·         Dollars coming in into the system (not such miniscule (!) amounts as USD 10 bn) is likely to push rupee up, thereby making our exports less profitable (think Infosys)

·         It also, to some extent, gives us a hint about the view of rupee in large corporate treasuries (responsible for raising such funds). If we can generalize these instances, (again, a risk of gross oversimplification) we can say that the rupee is seen as appreciating in the medium to longer term (If a Dollar is worth say, 45 INR today, and I have to pay 1 $ as interest, I pay only 45 bucks. But if tomorrow, Dollar becomes worth 55 INR, then also I have to pay 1$ interest, but in this case, I pay 55 rupees. And I’m earning in Rupees…Ouch !)

·         I take this as a fairly bullish sign for these companies – that instead of diluting more equity, they are going for debt.

·         Also, such debt results in a whole lot of new money coming in into the system, providing system with even more liquidity. This liquidity is later on going to be responsible for keeping further lending rate hikes in check…and probably even bring them down (however, for the effects to take place at such a scale, the debt borrowing has to be huge). So small and medium enterprises will be able to raise money domestically at relatively cheaper rates – resulting in their enhanced bottom-line.