Have the economists got it completely wrong?

Sep 23, 2010

In this issue:
» Surprises may spark another recession, says Stephen Roach
» Mutual funds did not take advantage of recent rally
» Yuan likely to depreciate and not appreciate feels Chanos
» India's event handling in sports comes into focus vis-a-vis China's
» ...and more!!

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The developed nations had unleashed the mother of all stimuli a couple of years back. It has averted a major crisis all right but we are nowhere close to a sustainable recovery. In fact, the effect of the stimulus is wearing off and it looks like we would be back to square one if further stimulus is not forthcoming.

All this makes us question whether the policy of stimulus is indeed the right policy in the first place? Certainly not, if one goes by a recent study of the European Central Bank (ECB). ECB has studied past economic recoveries across a group of nations. And it has come to the conclusion that it is not Government spending but rather spending cuts that leads to long term sustainable economic growth. Furthermore, it has argued that a Government should focus on reducing expenditure rather than raising revenues by way of taxes.

We believe that it is all about allocating resources. Since private sector allocates resources much better than the Government, its stimulus measures fail to have the desired impact. Thus, when Government cuts down its expenditure and instead, makes more resources available to the private sector, stronger and more sustainable growth takes place.

Spending cuts by the Government could lead to lower economic growth in the short run. However, ECB believes that the long term benefits are undisputed. Looks like the European Central bank has indeed hit upon the right formula. It is time the US Fed too follows suit. Otherwise, its suicidal policies of running a gigantic printing press may lead the US economy to a point of no return.

 Chart of the day
Today's chart of the day depicts the journey of the BSE-Sensex from 8,000 to 20,000 both in the current as well as the previous rally. In other words, it shows the time taken for the benchmark index to cross certain landmarks between 8k and 20k. One cannot help but notice how little time the Sensex has taken to go from 8k to 17k in the current rally as opposed to the previous one. This again points to the fact that it is a fool's errand to time the markets. If the markets are looking undervalued, they should be invested in right then rather than waiting for the trigger. Otherwise, the upsurge, like it has happened this time, could pass through one's eyes with breathtaking speed. And would be left doing nothing but ruing one's chances.

Source: CMIE Prowess

So the stock markets are up and how! Although they are particularly buoyant in emerging markets like India, the US bourses haven't been laggards either. This, despite their economy struggling to take off meaningfully after the financial meltdown. Hence, it doesn't come as a surprise that many experts are sounding a note of caution. One of them is Stephen Roach, of Morgan Stanley. He says, "When you have a sluggish economy, you don't have a cushion to help it withstand shock. If we get a shock, there'll be a relapse. Call it what you want, a double-dip (or) a new recession."

He also believes that the US central bank will find it difficult to respond to any ugly surprises. "The US Fed has already used up its traditional medicine and is now going to nontraditional medicine with a lot less firepower than the conventional interest-rate adjustments." The takeaway in all this for Indian investors is - while enjoying the current rally, do not get surprised if suddenly the flow of news turns all gloomy. Then as indeed now, seek dollops of value before you commit your hard earned money to any investment.

Even as the benchmark indices have been making rapid gains, domestic mutual funds have been net sellers for some time now. As the Sensex has risen from 17K to 20K, domestic fund houses have had to sell net assets worth US$ 2.5 bn. As per some reports though, this is not due to mutual funds selling as part of their investing strategies. They are in fact selling due to redemptions from investors.

Many investors were caught on the wrong side when the market was making new highs last time around (January 2008), and they got the most tempted to invest at that very stage. But with memories of the horrendous crash that followed fresh in most investors' minds, they have been pulling out of their mutual funds after every significant rise in the markets. This is surely a smart move. As one gets better valuations for the stocks one holds, it is always a good idea to take some money off the table. However, one needs to be careful to not get talked into investing once again if markets are to continue their upward rise in the short term.

US has been after China to strengthen its currency. The main reason given for this pressure is that China is keeping its currency, Yuan, artificially low in order to boost its exports. US says that this is hampering global trade as other countries cannot compete on the same ground. Expecting China to yield to the pressure has sent the prices of Yuan soaring in the foreign exchange markets.

However, major hedge fund founder, Jim Chanos has stated that this price rise is only temporary and that Yuan will weaken soon. He states that the Chinese property markets are going to go through bad times soon. This will lead to fall in the value of the currency of the country as a lot of its economic activity is centered around real estate. He goes on to say that the recent spurt in Yuan prices is simply driven by the US-China politics. As we all know gimmicks can't possibly sustain high prices. Eventually fundamentals will kick in and drive prices to normal levels and in this case, will drive Yuan to lower levels.

With respect to the Commonwealth Games in India, a comparison with China and its spectacular staging of the Olympic Games has been inevitable. China managed to awe the world with its world class infrastructure. India on the other hand is struggling to match up to its Chinese peer. Infact, the Commonwealth Games has been shrouded in disasters and embarrassment. And is fast tarnishing the country's image.

As a result, many countries were considering pulling out of the 54-nation sports competition. While the infrastructure is still crumbling, concerns have also been raised with respect to cleanliness of rooms in the Games Village and the security. Indian officials may be unperturbed and may believe that India will be able to carry off the Games in the end. But the way the scenario is panning out, it is a shoddy state of affairs indeed. And a setback for India's rise as a global power.

Meanwhile, Indian markets appeared in profit booking mode today. Although Sensex was trading below break even at the time of writing, it had managed to come off the day's lows. Asian markets closed mixed today whereas Europe has opened the day largely on a negative note.

 Today's investing mantra
"I think the (valuation) multiples of technology stocks should be quite a bit lower than the multiples of stocks like Coke and Gillette, because we are subject to complete changes in the rules. I know very well that in the next 10 years, if Microsoft is still a leader, we will have had to weather at least three crises." - Bill Gates

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12 Responses to "Have the economists got it completely wrong?"

K.G. Rao

Sep 25, 2010

The ECB, surprisingly, and u chaps with it, hv missed a vital point in concluding that public spending should be cut so more efficient pvt spending can increase. In stimulus spending during a recession, the extra spending by Govt does not mean les pvt spending, for after all the stimulus is from deficit financing. Seems obvious even to a layman like me. Where am I wrong?


Suresh Aithal

Sep 24, 2010

we Indian's are Proud of scintist, we are preparing to reach the Moon Soon.But It is very Shame that CWG are shrouded in corruption, mismanagement etc. What our grate leaders are doing.why they donot take acion in this matter.


r.prasanna venkatesan

Sep 23, 2010

The comments of Bill gates, about Microsoft is worth pondering. The color water giants of the world Coca Cola and Pepsi, are still riding high, but still the US and world consumers, will realise that it is better to drink plain water or some fruit juics, are more healthy and nourishing, and w2hen this happens, perhaaps, theworld qill be left with ore potable water, for its citizens, as these 2 companies and other beer,alcoholic drink makers, are sucking millions of gallons of water, not only from the rivers, but also from the ground. God save us from these color water giants and their alcoholic company cousins!:-))


niranjan dave

Sep 23, 2010



Kundan kumar

Sep 23, 2010

Its a good article, the
best i have ever read.



Sep 23, 2010

i dont no how to work sir u ple tel me



Sep 23, 2010

I would also like to compare the CWG organization with Asian games in 1982 under the leadership of Indira Gandhi. The 1982 asian games won many accolades for flawless organization whereas CWG are shrouded in corruption, mismanagement etc. The OC of CWG should be given severe punishment to set a precedent and no sane Indian would complain about it.


H P Roychoudhury

Sep 23, 2010

It is good to know India's economic pogress but it is shamefull to know the corruption in Common wealth games.


Swapan Sanjanwala

Sep 23, 2010

"ECB has studied past economic recoveries across a group of nations. And it has come to the conclusion that it is not Government spending but rather spending cuts that leads to long term sustainable economic growth. "

This debate and study has gone one for last century and is the cornerstone of major academic factions and fights. So its nonsense to cite one report. Spending cuts are fine when economy is doing good, but not in the face of an recession. That's the surest way for depression.

The basic economic identity:
public debt + private debt + trade imbalance = 0

It simply implies both government and the private sector cannot increase savings at the same time and still run a trade deficit. If they try it, the economic slump will get deeper..somebody has to spend to keep the economic engine moving ! Tax receipts will fall, leading to still higher deficits and deflation will set in. In a deflation burden of debt increases not decreases. Balanced budget orthodoxy was essentially what made the great depression of 1930s worse.


Vivek Mahajan

Sep 23, 2010

I refer to your comments... "This again points to the fact that it is a fool's errand to time the markets. If the markets are looking undervalued, they should be invested in right then rather than waiting for the trigger....." contained in "Chart of the day". Please do let me know if you are pointing towards the use of technical analysis as a market timing tool. If yes, I shall be glad to enter into a "healthy" debate with you in this regard. Having spent almost 30 years in the financial markets,I forthwith and most humbly accept the fact that I am still a learner and perhaps not as knowledgeable and experienced as you. But one thing for sure that on one hand your claims about "valuation"- based investing seem to be exaggerated and on the other hand your remarks on timing tools appear to flow out of sheer ignorance of the timing methods. There are hundreds of instances where both the methods fail at some time or the other, yet both fundamental and technical analysis (timing) have their own set of advantages. Such scathing remarks about timing should better be avoided.
Vivek Mahajan

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