V is the mould in which the market has been cast. With a correction expected in the second half of May and during July-September, those who invest for the long haul will emerge winners.
It is not only global stock markets that have traced out a V shape in the 19 months since Lehman. Most world economies have experienced a business-led recovery with technology, infrastructure, materials and energy leading the way. Stocks today are cheapest since 1990 on a ‘V-shaped profits boom’ basis.
The script of the Greek tragedy and choreography of the Spanish dance are by now baked into the cake. Stock markets move on new news, not old news. You cannot get junkier than junk.
What appears as a source of despair should be a cause for reassurance. Greece, as messed up as it is, can still borrow. Pessimists are forgetting that as recently as 20 years ago, responsible borrowers like Germany were paying as much to borrow money as shaky borrowers like Greece and Italy are paying today. Fear of a false factor is always bullish.
Events are making life easy for the Federal Reserve, which, in turn, makes life easier for everyone else. Last week’s Federal Open Market Committee (FOMC) statement did not signal a start to the process of lifting rates from their current ‘exceptional’ lows.
Instead, it laid out a Goldilocks scenario, in which growth is not too hot, not too cold. Inflation is ‘likely to be subdued for a time’, while economic activity ‘has continued to strengthen’. The Greek crisis has helped; by driving funds to the US and strengthening the dollar, it has helped damp inflationary pressure.
The reasons for strong undercurrents are many. Companies slashed their inventories post-Lehman as demand collapsed. However, a light pick up in demand was enough to lead to an inventory restocking boom. Judging by the ISM surveys, this effect was strong, but it has by now largely played itself out.
Second was the impact of government stimulus spending.Third, trade figures and capital expenditures have started to improve, suggesting that companies now have the confidence to plan for expansion as there is much ground to make up.
Fourth, the ISM supply managers’ survey — where 50 marks the dividing line between expansion and recession — is now at 59.6, its highest reading since July 2004. Payrolls of US private sector, which started falling since Lehman went under, grew by 1,23,000 last month. Non-farm payroll data is noisy and prone to revision, but is keenly watched, and has, of late, sparked optimism.
Fifth, the purchasing manager index, a widely-watched leading economic indicator for the US, is wildly expansive in emerging markets. Those markets — India, China and Brazil, among others — make up more of global GDP than the US does.
Sixth, in Europe, which is lagging the rest of the world, business confidence data from the German IFO and ZEW surveys and Belgian confidence data point to a broader recovery, taking over from the restocking boom.
Seventh, wage inflation has been relatively benign — in the US, we have seen the first decline in hourly wages in 20 years — offsetting soaring commodity prices — value of metal in a 5-cent US ‘nickel’ coin that also contains copper, currently stands at 6.2 cents.
There have been 16 real Dow Jones Industrial Average (for which most data is available) recoveries since 1896. High inflation, such as during the 1974 recovery, gives an exaggerated sense of price growth. Deflation, which accompanied several of the earlier market cycles, makes recoveries appear weaker.
Investors will do best to recall that even a ‘tortoise rally’ eventually crosses the finish line. Is there steam left, however?
The GDP-weighted global yield curve — spread between long-term and shortterm government interest rates — is steeper than it has been since the 1960s. Banks borrow short-term money and lend long term. A wider spread means higher bank gross operating profit margins. This is bullish because it reflects future eagerness to lend and has historically been a great market-timing tool.
The spread between 10-year Treasury yields and the average cost of credit default swaps has narrowed to zero, indicating the US economy — at the epicentre of the credit crisis — is keyed to expansion and credit demand, which is bullish.
Investor’s mood is to notice anything bad — 9.5% US unemployment, the RBI’s rate hike, Chinese rate tightening and risk of its bank lending atrophying — while treating anything good — narrowing credit spreads and fiscal consolidation steps in Budget — with trepidation. Healthcare legislation in the US is an Obamanation, and so on. This is the wall of worry bull markets love to climb.
Does China matter? On February 26, 2007, the Shanghai Composite index, which had rallied for months, suddenly fell 268 points, or 8.8%. A global selloff ensued. As it turned out, the first Shanghai bubble kept inflating for six more months before popping in October 2007.
The benchmark Shanghai Composite Index has recently fallen to its lowest level since last September when China’s economic recovery began to gather pace.
Administrative measure has been announced to curb real estate speculation including raising minimum deposit and interest rates for home mortgages, reintroducing a sales tax and outright ban on families buying third homes.
A soft landing for a bubbly housing market could help underpin the rebound in the economy in the medium term. If impact on prices is limited, it could force the authorities into harsher measures that could be devastating for an infrastructure-reliant economy such as China’s.
Looking at global trends, stock prices could correct in the second half of May and between July and September 2010. Washington’s relationship with Wall Street could get so schizophrenic as to lead to the arrival of the Minsky moment at which markets could correct.
However, as the enclosed chart illustrates, those who invest for the long haul emerge winners. In the short term, the V will continue until all sceptics have given up. Only at that point will the stock market sketch out a W.
) Mahindra Capital and SBI (
) Capital Markets to manage the offering. 
