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Free money, currency wars and a Sensex crash: What's in store for markets

What explains the 855-point crash in the BSE Sensex and the 251-point slide in the Nifty today (6 January)? Has anything gone phut in the Indian economy all of a sudden? Or is the world caving in?

Most important question: Is this a time for greed or fear in the stockmarkets? Should we be buying stocks, sitting tight, or selling to cut our losses?

 Free money, currency wars and a Sensex crash: Whats in store for markets

The Sensex crash has very little to do with what’s happening in the Indian economy, for the growth trajectory is fairly clear. Reuters

The short answer is probably a little greed, and lots of caution. But selling is not what the doctor orders for now – assuming, of course, you have not bet the farm on stocks and only the portion you can afford to risk.

But, first, let’s see why stocks have crashed. It has very little to do with what’s happening in the Indian economy, for the growth trajectory is fairly clear. The economy has bottomed out, inflation is under control, and interest rates are expected to fall at least from the first quarter of 2015-16. Most important, the Modi government is planning on a massive dose of public investment (possibly in the range of Rs 2-3 lakh crore) to boost the economy, benefiting from favourable oil prices.

So what’s gone phut is the rest of the world, barring America. Europe and Japan are struggling with zero growth and practically no inflation (rather, they are trying to stave off deflation), China is slowing and cutting rates. Interest rates are near zero in the big developed economies of the US, Europe and Japan.

African and West Asian oil producers are fighting a price war for market share, and America has added fuel to this fire by opening up exports for its own shale oil. In a sense, Saudi Arabia and US shale producers are in an eyeball-to-eyeball confrontation to get the other out of business. Weaker oil has already brought West Texas Intermediate crude prices to below $50 a barrel, and Brent oil, India’s benchmark, is at $52. The Russian rouble is in a free fall, and oil dependent economies like Venezuela (and some others) are on the brink of defaults.

In this deflationary scenario, the world’s big economies are likely to be awash with free money – and they are clearly heading that way. Average interest rates on 10-year government bonds in the US, Germany and Japan have fallen below 1 percent, with US 10-year Treasury offering a yield of 1.28 percent, its German counterpart a piddly 0.55 percent and the Japanese yen bond a pathetic 0.28 percent. At these yields, people are investing in government bonds merely for safe-keeping, not returns.

Near-free money in the west (especially after adjustment for minuscule inflation), and currency and commodity price wars have brought back fears of a global recession a la 2008. This is why the markets are falling all over.

In this scenario, where the US is the only robust economy, with GDP growth hitting a 10-year high of 5 percent in the third quarter of 2014, there is the possibility of the US Fed actually raising rates by mid-2015. This can be destabilising if risk-averse money heads back to the US. But given the backdrop of a declining Europe, Japan and Russia, and a slowing China, the Fed may well delay its tightening since it will be importing deflation.

Now, one can attempt to answer what happens in India, assuming the rest of the world is reflating to prevent negative growth.

It is more than likely that the domestic economy (and markets) will feel the headwinds of a global slowdown, but the Indian situation will improve next year as the growth downcycle has probably bottomed out and the government is planning a massive public spending stimulus to revive investment and growth.

Ask yourself, if the world is going down a barrel (barring America, and to a lesser extent India), where should the long-term money flow? To the growing parts or the rest of the world?

Also remember, when interest rates are near zero abroad, and Indian real interest rates are still very high (8percent repo rate, against zero WPI and 4.38 percent CPI), where should debt funds flow?

Also ask yourself: when money is free abroad, the chances are easy money will inflate asset prices – which is what happened for most years after 2008. The question is whether we are back to that situation. If money and liquidity are easy, the chances are asset prices everywhere will bloat. India could benefit.

In the foreseeable future, India real interest rates will continue to yield a positive return after inflation, since RBI chief Raghuram Rajan is a hawk on inflation and will ease only slowly.

But the rate trajectory will still be downwards, and this is a positive both for debts and equity.

Methinks, after a period of correction driven by global bad news, the smart money should head to India, among the few other luckily placed emerging markets.

This is why one can be cautious for a few weeks to check which way the wind is blowing; after that it may be time to be greedy and start buying beaten-down stocks.

The only caveat: don’t buy any share in which you cannot afford to wait three years to sell. Also, stick to blue chips, which tend to fall less in a weak market.

A little greed won’t be a bad thing, but too much of it can give you sleepless nights.

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Updated Date: Jan 07, 2015 09:00:03 IST