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Three down years? - Views on News from Equitymaster
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  • Jun 8, 2002

    Three down years?

    There was a sigh of relief at start of the week, as markets registered three consecutive winning days. However, momentum could not be maintained with much of the gains being wiped out by weekend. Selling in a rally, travel advisories compounding war fears and flailing U.S markets are likely to have taken a toll on sentiment.

    Many believed that the U.S bear market, which has been around for a little more than two years, was over after a sharp run in equities post September 11. But then many expected a turn in sentiment in the second half of 2001, which was pushed forward to latter half of 2002. It seems, that another revision in expectations is likely. Window dressing virus hitting U.S corporations, geo-political tensions in Mideast and South Asia and investors' questioning equity valuations have marred sentiment on the bourses.

    With fears of economic downturn getting more pronounced U.S Fed cut interest rates through 2001 to their 40-year lows. Lower interest rates allows for an expansion in equity valuations, as it justifies a higher asset price. But it does not address the unrealistic expectation already built into asset prices, which seems to have kept values inflated post rate cuts. The Fed, it seems, has bought time for revival in economic growth, which could lead to adjustment in valuations. However, it seems, recovery will have to be robust, which is contrary to expectations, to justify prices. Also, war fears and accounting shenanigans only warrant lower valuations.

    The U.S economy has held firm largely due to consumer spending. Individuals were offered a tax rebate last year leading to higher disposable incomes. Also, a boom in the real estate market has allowed benefits to be extracted from mortgages. Having said that, the housing boom is tapering off. The U.S consumer is over-leveraged with negative savings. Therefore, it is likely, that consumer spending may not fully support future economic growth. Consequently, corporate spending may need to take up the mantle. On a theoretical note, lower interest rates encourage higher investments leading to higher incomes. As incomes increase the marginal propensity to consume decrease leading to more savings. This could balance saving-investments in an economy leading to equilibrium.

    There seems to be confusion at diplomatic levels between India and the West. The travel advisory has been further heightened in the region despite India - Pakistan calming nerves that they will not act irresponsibly. A good explanation could be that foreign diplomats have not been able to correctly read the situation with divergence in public statements and private intentions of Indo-Pak leaders, which is the hallmark of South-Asian politics. War fears are likely to be stretching, which could lead to investors' looking for fresh catalysts. Focus is likely to shift towards the economy and expectations on monsoons and industrial revival.



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