Optimism Play Bulls Are Back Atleast For Now Vinit Tulsyans Views On Markets And Economy
March 11, 2009
HOPE BACKED UP WITH FEAR TO DRIVE THE MARKETS AS
MARKETS TRY TO FIND A BOTTOM WITH TODAY’S GLOBAL
RALLY, BUT HAVE THEY REALLY FOUND ONE : I DON’T
I write this article, following my earlier articles, In my view, the Indian equity market, in wake of
less news flows, with anticipation of more of bad news flows rather than good ones on domestic
front will move largely on the back of 1) moves seen by global equity markets, and 2) global news
flow or as events unfold globally especially US.
These events as and when unfolds will be the guiding factors for Indian markets as I do not see
any news flow to come either from govt. (due to elections) or RBI (due to its own problems). As
of now at-least for next 3 to 4 months hardly any action is anticipated on fiscal policy front by
the govt., (restrained by widening deficits) which is the need of the time to infuse confidence and
stimulate economy. On monetary policy front I do not see any other rate cuts at-least in the near
time frame. Though some news flows, on which our markets could react on, would be IIP
numbers, Inflation data, GDP data etc but only on that particular day and in my view is less
expected to provide any guidance to the markets for the medium or long term.
With further expectation of formation of a coalition govt. at the centre, and with the priority
given to tackle the deficit and borrowing problem, there is little good news I expect from the
newly formed govt.’s full budget (as and when they present it). For details refer my earlier article
titled, “More bad news in store than good” at http://vinittulsyan.wordpress.com.
Governments/Treasuries all around the globe are pumping money into their economies to
counter the worst financial crisis since the Great Depression still with confidence shattered all
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around the globe, the equity markets or the main stream market s everywhere are dreadfully
looking for anything beyond just one word i.e., HOPE.
The global macro data suggests that things are extremely bad
The US real GDP contracted sharply at an annualised rate of 6.2 per cent in the fourth quarter of
2008 and the unemployment rate in the US has moved up to 7.6 per cent. The real GDP in the
euro area also declined by 1.5 per cent in the fourth quarter of 2008. Reflecting deteriorating
global demand, Japanese exports fell by 45.7 per cent (y-o-y) in January 2009. The Japanese
economy also contracted sharply by 3.3 per cent in the fourth quarter of 2008. The fourth
quarter real GDP numbers of several advanced economies have turned out to be worse than
expected. The uncertainty, therefore, on global recovery has increased.
Things are so bad that just a bit of good news can spike the market though they are
just short term spark in my opinion
Things are so bad, that people are looking for just a little (as little as a word of assurance) of
good news to build a bit of confidence or to assure themselves that it cannot be bad from here
onwards. But I have little idea on whether this lookout for even a smallest of good news is good
enough to provide them enough confidence or is it good enough that it will be able to provide
little bit of foundation to a collapsed banking and financial system, which in turn are the
foundation of any economy. But one thing is for sure, that this bit of good news, which came in
today, was good enough to push both, European and US markets higher by xx%, a jump not seen
in recent times.
What was the good news?
1. The good news came in form of assuring words from Mr. Pandit, CEO of the most
troubled US banking giant i.e., CITI Bank. Mr. Pandit in a letter sent to employees said
“the bank had an operating profit of US$8.3 billion before taxes and special items
through February—its best performance since the third quarter of 2007”, though he
declined to what were the provisions for credit losses and write downs. Another
reassuring word came in form of Citi running its own stress tests for the bank at levels
worse than those being used by the government and Mr. Pandit is confident in the bank's
capital position based on those tests
2. Markets found a sense of wisdom within comments made by Fed chairman, Mr.
Bernanke, as he again emphasized on revamping country’s financial regulatory
system. Though I am surprised, why on earlier occasion, markets did not find a sense of
wisdom on the same statement made by the same person. Not few years back, rather
before this crisis actually began i.e., September 2007, the same statement on “more
regulation” would have sent markets for a complete toss.
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3. The uptick rule (chances of it coming back): The regulatory authorities in US taking a
second look at the uptick rule; the uptick rule limits short-selling in stocks. The uptick
rule allows short sales only when the last sale price was higher than the previous price.
The rule was first adopted in 1934, five years after the 1929 stock market crash, to
prevent short sellers from adding to the downward pressure on a stock that is already
falling sharply. The rule was repealed in June 2007. It only allows shorting shares only at
a price higher than the previous price. One cannot sell a stock, if the last tick is negative,
it has to be positive. It will prevent short sellers from piling on. The expectation is that it
will discourage short sellers in taking position; as most of them had been held
responsible for hammering down the stock prices. The markets took a strong cue out of
it, and with prevalence of word called HOPE, market railed on the back of expectations
that once this uptick rule comes back, short sellers would not risk shorting the shares.
There was one bad news for the markets as well but HOPE completely ignored this
news and looked for good news within this bad news
1. There were some speculations doing the rounds in US that SEC (Securities and Exchange
Commission) would suspend the controversial regulation called MARK-TO-
MARKET (MTM), at-least for the time being but it never happened. Though I believe
removal of this regulation will result in banks being able to account for their hard-to-
value assets more favorably amid this distressed markets condition; resulting in trying to
find some meaning in each of their assets and try and show a better financial position. It
will also add some level of easing in their balance sheets, which are getting continuously
marked down and in a way it is good, as investors get a true picture of the company’s
The good news picked by market participants within this was comments made by Mr.
Bernanke, who reiterated that he does not support suspension of mark-to-market,quot; but
he would like to see more done to provide guidance to banks and financial firms on how
they can give indications of value for assets being traded under fire-sale market
Market participants also found hope from these assuring words by Mr. Bernanke, who
said that the U.S. recession could end this year only if the government is successful in
getting financial markets to operate more normally again. But there is again a big IF in
But the problem is, that despite of this debate over Mark-to-Market accounting,
people, investors are so skeptic, so wary about asset quality of these already troubled
banks that stock would be hammered even though these regulations are withdrawn, as I
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believe in today’s world investors are so informed that they can have their own
assessments of these troubled assets.
2. Businesses slashed inventories at the wholesale level for a fifth straight month in
January, the longest stretch since the last recession in 2001 and a warning signal that
companies are likely to keep cutting production as they cope with the deepening
Yet another bad news was ignored
3. Credit card delinquencies hit index record as cash strapped American consumers
are not paying credit card bills on time, sending delinquency rates to their second
straight record high in a report compiled by a credit rating agency. The latest numbers
point to even higher default rates and worsening consumer credit quality measures in the
And the word of assurance in form of good news was followed by a huge rally with
50% higher volume then average volume, Wall Street and European Indices did
not witness for a long time
The Dow Jones industrial average gained 380 points, or 5.8%, S&P 500 index gained 43 points,
or 6.4%, after ending the previous session at the lowest point since Sept. 12, 1996. The NASDAQ
composite climbed 90 points or 7.1% after ending the previous session at its lowest point since
Oct. 9, 2002. The rally was led by financials with Citigroup stock jumped 38%, leading a broader
rally in the financial sector. Within other banking stocks such also gained double digit with Bank
of America (27%), HSBC (11%), American Express (14%), Wells Fargo (19%), JPMorgan Chase
(23%), Goldman Sachs (15%) and Morgan Stanley (26%) were among the stocks rallying.
In global trading, European markets rallied on the back of financial stocks with FTSE, DAX and
CAC gaining 4.9%, 5.3%, and 5.7% respectively. Asian markets ended mostly higher with
HANGSENG and Chinese market gaining 3.1% and 1.9% respectively.
Why are the banks stocks looking good and investors just wanted a bit of good
news flow to drive away the stock prices from OVERSOLD POSITION?
Because of the fact that the overall pie has become smaller as so many other investment
banks have gone down. For an investment bank like Goldman Sachs, some of the best
year they had was after every stock market crash. The existing or surviving investment
bankers would benefit by a larger market share and reduced market pie (with respect to
number of players).
With losses and write downs at record high for almost every bank in US, these banks
would like to capitalize on the back of hope to apply against taxes on future profits.
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Stock prices never go to zero (till the time market participants believe in going-
Though words of Citi's performance by Mr. Pandit at least temporarily broke a flood of bad
news from the banking industry, but I have my reservations regarding the markets are about to
barrel higher from now onwards. With little chances of any company’s stock price going to zero
as investors then try and find a sense of wisdom and value in that company through some
parameter only they understand. Taking the case of Citi’s, there is absolutely little probability
that its stock price is going to go to zero, as investors then will try and find meanings into
different words (once they were considered good but now have become a word of abuse) such as
SUB-PRIME MORTGAGES, MBS, ABS, CDS, CDOs, CLOs etc. So as of now it seems more likely
that it is just a bounce on the back of OPTIMISM and HOPE and is in a slope which is heading
downwards, and is a classic example of famous words such as RELIEF or BEAR MARKET
rallies or SHORT COVERING. The caveat out here in my opinion is that Mr. Pandit at-least
now is “dealing from a position of underappreciated strength” as in the last quarter Citi
has lost US$28.5 billion due to write down the value of money-losing bond market and
The good news Citi can rely on is realize the majority of their deferred tax assets (DTAs). The
extreme troubled times, write downs, huge losses could just turn out to be a blessing in disguise
for Citi as due to the losses the company has accumulated over these troubled times, the
company hopes to apply against taxes on future profits.
The classic bear market or short covering rallies are expert in, sending wrong
signals or changing one’s perception
As markets try and find a bottom, then these rallies are pretty common, as it happened with all
the markets (including our own) in October 2008, and few people then tried to find a bottom in
that huge sell off. And subsequently a bear market rally led few participants believe that the
worst was seen but…….
…But markets had to go back or respond to realties faced by the economy as in US, markets now
only tested those lows, but broke them and went on to match levels prevailing in 1997. European
markets did the same and our markets are on the verge of doing so.
I believe what Mr. Obama is doing is just right though Market does not seem to
What I believe, is that what Mr. President is doing to bring back the economy on track is just the
right thing to be done. Though markets are not pleased and indices are at multi-year low, but he
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is at-least trying to re-build the foundation by directly looking at American people and not to
please the market. Markets are not pleased because Mr. Obama is not buying bad assets from
troubled banks, instead he is choosing to pick equity stake in those companies, to ensure there is
more oversight. His USUS$ 75 billion plan for US home owners is just in the right direction. He
is investing in education, bringing in health care reforms, investing in infrastructure, decreasing
reliance on importing oil etc., from the USUS$ 787 billion economic stimulus plan, which he got
it passed and converted into law. Though, his stress test plan, which was announced earlier is
taking time, but the time taken is justified as it gives the law makers determine, how bad is the
real situation and who needs actual support.
It seems he has taken lessons from China, whose stimulus plan of more than USUS$ 500 billion
announced in January, sent worlds markets soaring. The plan focused on building infrastructure
and investment into areas, which has left China weak i.e., EXPORT. I believe that increased
spending will spur earnings after an export collapse dragged the economy to its weakest growth
in seven years. The Chinese plan focuses on reducing its reliance on exports, boosting domestic
consumption, providing support to local industries etc., which in my opinion was the way for
I believe the latest stimulus of US$ 787 billion will attempt to spur job growth and revive the
world’s largest economy and provide necessary impetus for creating a virtuous economic cycle
which starts with Jobs Creation.
When things are bad and bad to the core, no one talks good and here no-one
includes IMF and World Bank and other market participants
1. IMF says the global growth to slow below zero: International Monetary Fund
director says worldwide recession could cause global economy to contract by as much as
3% this year. Continued de-leveraging by world financial institutions, combined with a
collapse in consumer and business confidence is depressing domestic demand across the
2. World Bank: Economy worst since Depression: World Bank says global
economy to shrink for first time since World War II dragged down by sharp
decline in industry, trade. As per World Bank views, the world economy are on track
to post its worst performance since the Great Depression, with developing countries
bearing much of the economic pain. Those countries face a credit shortfall of up to
US$700 billion. quot;Many institutions that have provided financial intermediation for
developing country clients have virtually disappeared. Developing countries that can still
access financial markets face higher borrowing costs, and lower capital flows, leading to
weaker investment and slower growth in the future.
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3. A new problem in form of Credit Card evolving up: Is it the new “BIG”
problem in the making: Views by Meredith Whiteney, a prominent banking
analyst (source CNBC.com): Whitney warned that quot;credit cards are the next
credit crunch,quot; as contracting credit lines will lower consumer spending and hurt the
U.S. economy. Few doubt the importance of consumer spending to the U.S. economy and
its multiplier effect on the global economy, but what is underappreciated is the role of
credit-card availability in that spending.
She said though credit was extended quot;too freely over the past 15 yearsquot; and
rationalization of lending is unavoidable, what needs to be avoided was quot;taking credit
away from people who have the ability to pay their bills.quot;
Whitney said available lines were reduced by nearly $500 billion in the fourth quarter of
2008 alone, and she estimates over $2 trillion of credit-card lines will be cut within
2009, and $2.7 trillion by the end of 2010. quot;Inevitably, credit lines will continue to be
reduced across the system, but the velocity at which it is already occurring and will
continue to occur will result in unintended consequences for consumer confidence,
spending and the overall economy,quot;.
As per her estimates, there is roughly $5 trillion in credit-card lines outstanding in the
U.S., and a little more than $800 billion is currently drawn upon. And she expects that
there will be at least a 57 percent contraction in credit-card lines.
Over the past 20 years, Americans have also grown to use their credit card as a cash-flow
management tool, adding that 90 percent of credit-card users revolve a balance at least
once a year, and over 45 percent of credit-card users revolve every month.
4. Credit Is Tightening Again (source CNBC.com): Several metrics that market
analysts use to gauge the availability of credit have been signaling trouble in recent days,
throwing up a caution flag that tougher times could lie ahead for the availability of cash.
That's a formula that always spells trouble for investors.
Among the signs that analysts say point to credit problems are Libor, or the rate banks
charge each other for overnight lending; The quot;Ted spread,quot; which is the difference
between 3-month Libor and the 3-month Treasury bill; two-year credit default swap
rates; and the Commercial Mortgage-Backed Securities index, or CMBX.
Libor rates have swelled to prices not seen since December, with the trend indicating a
June three-month rate of 1.7 percent. A widening in Libor emanates from lower
confidence that institutions have in each other and leads to tighter lending policies.
Similarly, the CMBX and the two-year swap spread both are at four-month highs, while
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the Ted Spread, which indicates willingness to lend, also is moving lower, and falling
1.09 percent on Tuesday, 11th Mar’09.
Other indicators that have analysts concerned include the difference between investment
grade bonds and Treasuries, as well as increasing problems in the commercial real estate
business that will be reflected in the CMBS rates and other metrics.
I believe that, unless we start seeing a reversal of the widening of a lot of these credit spreads,
any equity rally is going to be short-lived. And the same problem, though in smaller magnitude
then US or Europe is prevailing in our markets as well. Soaring bond prices and lowering yields
are just some of the exciting reasons for our financial institutions to park their money in govt.
securities and bond market, rather than letting the credit flow in the system.
The RBI direction
Despite RBI providing clear direction to the banking industry, that the interest rates have to
come down either by meeting them directly or through rate cuts but this still is not necessarily
getting transferred into credit flow and this is getting reflected in data released by RBI (see
Negative news for India continues (Source: RBI press release on the day of rate
cuts) with evidence of further slowing down of economic activity.
Exports registered negative growth for the four recent consecutive months, October
Overall exports growth during 2008-09 (April-January) at 13.2 per cent was
significantly lower than 24.2 per cent during the same period of the last year.
The index of industrial production (IIP) registered a negative growth of 2.0 per cent
during December 2008, with the manufacturing sector returning a negative growth of
2.5 per cent.
IIP growth during April-December 2008 at 3.2 per cent was about one-third of 9.0 per
cent during the corresponding period of the previous year due to slowdown in all the
The services sector, which has been the main engine of growth during the last several
years, has also been slowing down.
Business confidence has been dented significantly and investment demand has
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Non-food bank credit growth reached a peak of 29.4 per cent (Rs.5, 82,344 crores) on a
year-on-year basis as on October 10, 2008 as compared with 23.3 per cent (Rs. 3, 74,054
crores) as on October 12, 2007.
Subsequently, year-on-year non-food bank credit growth decelerated to 24.3 per
cent as on December 19, 2008, as credit expansion during the period between October
10, 2008 and December 19, 2008 at Rs. 30,889 crores was much lower as compared with
Rs. 1, 05,774 crores during the corresponding period of the previous year.
Non-food bank credit has decelerated further to 19.7 per cent (y-o-y) as on February 13,
2009 as compared with 22.7 per cent as on February 15, 2008
As credit expansion during the period between December 19, 2008
and February 13, 2009 at Rs. 8,091 crores was sharply lower than that
of Rs. 86,978 crores in the corresponding period of the last year.
Non-food bank credit expansion remains below the indicative projection of
24.0 per cent in the Third Quarter Review of the Monetary Policy.
The total flow of resources to the commercial sector from banks and non-banks during
2008-09 so far (up to February 13, 2009) at Rs.4,98,136 crores was lower than
Rs.6,08,351 crores during the corresponding period of the last year.
When would things start looking good?
In my opinion, thing would start looking good only when there is enough transparency on asset
values. I feel that the transparency will be brought in by the stress test introduced by Mr. Obama
as that will be time when the situation at the ground level becomes clearer. That will be time
when banking stocks will bottom on the back of Mr. Obama Plan and already 0% Fed rate.
In Indian context, as and when the main stream market (the credit market) stabilizes, there is
a smooth flow within credit market, and this will only happen when the FEAR word in the mind
of financial institutions gets replaced by HOPE. This will further gain momentum after a series
of another bad macro data and lower inflation data as this will propel the central bank to further
lower the Repo and Reserve Repo or may be lower the statuary requirement with respect to SLR
Another factor for things to start looking good would be the one when commodities markets
bottom and Rupee strengthening against major currencies, though this looks like a remote
possibility looking at the problem the economy and the currency faces (refer my earlier article
titled “more bad news in store than good news”)such as:
Further selling by FIIs in Indian equities market
Widening deficits; subsequently drastically increased Govt. borrowing program
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Further decline in foreign currency assets reserves
Further ratings downgrade by global rating agencies
Less or negative flow of FDI or FIIs money in the country
Reducing interest rates
Grim Chances of RBI intervention in the Forex market to stabilize INR
Still not a currency of immense bargain around the globe
Possibility of Indian residents also transferring savings out of the country
Though I have little expectation from the any government forming the next government at the
centre in terms of policy front, but as the credit flow eases along with increase in non-food bank
credit, easing interest rates and lower inflation, I believe markets would show signing of
stabilization with little risk of breaking down. This will translate into consumption growth which
will spur manufacturing activities and subsequently the headline data would start looking better.
Though, that time I believe is still FAR AWAY.
Warm Personal Regards,
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