Do bonds point to a slower US recovery? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Do bonds point to a slower US recovery? 

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In this issue:
» Unemployment in Eurozone remains high
» Lower rates have not reached the common man yet
» Roubini is optimistic on the US
» The threat to Asia's reviving growth
» ...and more!

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Is there a recovery visible in the US economy? From the trend in the stock and bond markets conflicting signals have emerged. If one looks at the recent rally in stockmarkets, it would appear that the economy is recovering strongly. However, bond markets tell a different story which is that the recovery is expected to be a long and slow one.

So which of the two presents the correct picture? While both may not necessarily be an accurate indicator of what is to come, it appears more likely that the bond markets present a truer picture. An article on Moneynews states that investors sent US$ 52 bn into stock funds and stock-based ETF in the first quarter, the most in nine years. At the same time, fixed-income funds took in US$ 65.7 bn, the most since 2006.

The rally in the stock markets has been more a product of too much money finding its way into various asset classes, equities being one of them. Since the crisis broke out, the US government has been on a money printing spree, announcing 3 massive rounds of quantitative easing. None of this has led to either capital creation in industries and infrastructure. The money has instead been channelized into equities. Meanwhile, economic activity in the US has continued to remain weak and the latest data on jobs has further reinforced this. According to the Labor Department 88,000 jobs were created during March, while economists had forecast for 190,000 new jobs. The unemployment rate did fall slightly to 7.6%. But that has largely been attributed to job hunters dropping out of the labor market. Not just that, the participation rate (the number of working-age people working or seeking work) dropped to 63.3%. This is the lowest since 1979.

In such a scenario it is hardly surprising that the bond markets are finding takers. All of this leads to the conclusion that the recovery in the economy is most likely to take much longer than expected. And that is bound to have repercussions for the global economy as well. The US Fed and for that matter even governments in Europe and Japan would be better off if they realise the futility of announcing endless QE programs. But if the latest action of Japan is anything to go by, that alas does not seem to be the case.

Do you think that the rally in the stock markets point to a recovery in the US? Please share your comments or post them on our Facebook page / Google+ page

01:26  Chart of the day
High unemployment continues to plague the Eurozone. According to the Economist, unemployment in the 17 member states stood at 12% in February. This is the highest in the region's history. Indeed, the chart shows that unemployment in Greece, Spain and Portugal was higher in early 2013 than what it was a year ago. Germany, on the other hand, fared much better. The biggest worry for the region is the rise in the number of youth unemployed. This could have serious implications going forward in the form of seething discontent and revolutions if the problem is not addressed sooner. But so far the region has shown no inclination towards this other than printing money to bolster growth.

Data Source: The Economist

What would happen if interest rates were left to market forces? In other words, let them be determined by the demand and supply of money. We don't know about other countries but in India at least they would have been higher than what the Reserve Bank of India (RBI) has set them to be currently. Simply because even after the central bank has lowered rates and eased liquidity, benefits in the form of a lower interest rate have not reached the common man yet. An article in Wall Street Journal puts this down to asset liability mismatch and rising NPAs in the Indian banking system.

Indian banks, mostly the PSUs, are increasingly funding their long term loans through short term deposits. This is then leading to huge asset liability mismatches, which is keeping the cost of funds high. Besides, higher NPAs mean banks have to keep aside more money as provisions, thus forcing them to keep interest rates high on its other loans. As a result, unless these pressures ease, lower interest rates by RBI may not translate into lower interest rates for firms as well as retail consumers.

We live in a relative world. When we say something is doing better or worse, we're essentially comparing it with something else. Consider this recent news. Nouriel Roubini, a renowned economist, is optimistic about the US economy and the stock markets. At first glance, this seems surprising. How can one be optimistic about an economy struggling with heavy debt burden and anemic growth? Go back to what we said in the beginning. It is only in comparison to Europe and Japan that the US seems better off.

What are the factors in the favour of the US? As per Roubini, the US is in a better position to deal with its debt burden. The housing sector has been witnessing some recovery. Lower energy cost due to the shale gas revolution is another booster. And the fact that wages are rising in Asia could prompt businesses to invest in their home country. Despite these positives, Roubini expects the GDP to expand by merely 1.7% this year. This is lower than last year.

But there is one point on which we strongly disagree with this gentleman. Roubini is bullish on US stocks. What are his reasons? One, gradually improving growth. His other reasons are the US Fed's monetary easing program and 'low risk factors'. In our view, it is a bit early to call an end to the ongoing 'Great Correction' in the US. Short term improvements are not reliable indicators of changes in long term growth trends. And lastly, if you're relying on the central bank to pump up stock markets, is that low risk? We certainly do not share Mr Roubini's optimism on the US stock markets.

After reading several criticisms on the US it was a change to come across an article in MoneyNews by Morgan Stanley's Ruchir Sharma. Mr Sharma has stated that with the way things are going US maybe a better investment bet as compared to the BRICS. His reason for this fascination is the debt being taken on by the BRICS. He has stated that the BRICS particularly China are fuelling their growth through debt. The interesting static quoted by him is that China's debt has reached 200% of its GDP. This means that it has US$ 3 of debt to generate a growth of US$ 1. This is worrisome. Because the developed world is a testimony of how debt cannot fuel growth forever. Eventually all the debt will come back and catch the country off guard. And when it does the only way for the country's growth would be to go downwards.

While we do agree with Mr Sharma that debt fuelled growth is dangerous; however it is for the same reason that we do not agree with him on his fondness for US as an investment destination. The thing is that the US is printing money like there is no tomorrow. As such it is simply increasing its debt burden. So saying that US is better off may not be the right statement. Eventually the mountain of debt will topple. It is just a matter of time. On the other side of the world, not all BRICS are using debt to fuel growth. With better macroeconomic conditions as compared to the US, these present better investment opportunities in our opinion.

Economic growth in Asia has suffered due to global uncertainty and region specific issues. However, with growth bouncing back in countries like China and Indonesia, there are indications that a revival is on the cards. But Asian Development Bank (ADB) has warned that global political issues are turning out to be a major threat to Asia's reviving growth. For instance, authorities in the US are unable to find a solution to the fiscal problems in US. Austerity measures in the euro zone are creating a further fuss on which expenditures should be cut and how. On the other hand there are border disputes within some Asian countries which further increase political risk in these regions.

Nonetheless, ADB has forecasted that the growth in developing Asia will expand to 6.6% this year. However, inflation will be a matter of concern. With respect to India, the bank feels it will expand 6% this year and 6.5% next year.

Apart from this, ADB is also of the view that if Asia needs to achieve a decent sustainable growth rate it will have to secure clean and cheap energy. And in order to do that, it will have to tap cleaner energy sources like water, bio gas and wind. Or else the growth ambitions of the region could take a hit.

Led by selling pressure in stocks from the information technology and FMCG spaces, the Indian markets shed their morning gains during the post noon trading session. The BSE-Sensex was hovering around the dotted line at the time of writing. As for its smaller peers - the BSE Mid Cap and BSE Small Cap indices - they were trading higher by about 0.2% and 0.4% respectively. Stock markets in other parts of Asia ended the day on a firm note with China and Hong Kong up by about 0.6% and 0.8% respectively, while Japan ended flat.

04:56  Today's investing mantra
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