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International exuberance - Views on News from Equitymaster
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  • Jul 20, 1997

    International exuberance

    If you thought that surging stock prices was a phenomenon restricted to Dalal Street, look at the accompanying table. Surge on the bourses

     Index          Country   2 Jan 96    2 Jul 96    % change
     Dow Jones          USA      4,117       7,858        53.5
     FT-100              UK      3,698       4,810        30.3
     DAX            Germany      2,254       3,973        76.2
     SMI        Switzerland      1,132       5,947       425.3
     Bovespa         Brazil     42,991       3,494       213.8
     Hang Seng    Hong Kong     10,073      14,859        47.5
     Nikkei           Japan     19,868      19,705        (0.8)
     BSE - 30         India      3,110       4,291        37.9
     SET           Thailand      1,281         633       (50.5)

    Since 1995, international stockmarkets have been on an unabashed bull run, albeit for varying reasons. The US markets have surged by some 50 per cent on a `goldilocks' economy - that perfect balance of 2-per-cent-per-annum growth and low inflation rates, which allows interest rates to decline. In Europe, lower interest and the beginnings of an economic recovery have taken the stockmarkets to new highs. Even the gnomes in Switzerland, avid collectors of gold and bonds, have punted their markets to dizzying levels.

    The emerging markets have had a mixed review - Russia has been a blistering pace while Thailand has been one of the worst performers in the world. India demonstrated relatively respectable performance, mostly over the last six months. The reasons for the fever in the emerging markets varies from the perceived cheap sales of state assets (as in Russia), hopes of an economic and liquidity recovery (India), or just plain gambling on the future (the red chips in Hong Kong).

    In any case, the underlying euphoria is driven by one factor: cheap money, and lots of it. Ten-year borrowing rates in Japan are now at 2 per cent and in Switzerland at 3 per cent. In the United States, the 10-year bond yields 6.5 per cent and is expected to decline to below 6 per cent by the end of this year. Flushed with money generated by accommodating central banks, fund managers do not find it worth their while to put money into low-interest bonds and have moved to equity, commodities, and even property. This new environment has also seen a surge of private equity, or what we know as venture capital, with billions of dollars being bet on long gestation power projects and toll roads in China, India, Russia and Brazil.

    The brave are even saying that this is the dawn of a new era, of a virtuous cycle of prosperity and international co-operation, of an era where there will be no more business cycle. The proponents of this golden age theory suggest that the central banks have won their battle against inflation and can now fine-tune the global economy to generate real GDP growth rates of 2 per cent with low inflation, low interest rates, and lower unemployment.

    Ironically, the key central banker, Alan Greenspan of the Federal Reserve, described the surge in the US stockmarkets as a case of "international exuberance". When he made that statements, the Dow was 15 per cent lower than what it is today - just six months ago! A columnist in Forbes magazine argued that what Greenspan had said was "national exuberance" but the media had misquoted him!

    But maybe "international exuberance" better describes the optimism floating through the global capital markets. In a recent conversation with an international fund manager, he was at pains to explain to me how the fund management community was no longer pricing equity on the basis of earnings growth or price-to-earnings ratios. The key to the rise of the market was that interest rates were low, so people had no choice but to buy equity - after all, what can fund managers tell investors in mutual funds who have collectively parted with over $2 trillion (six times GDP of India) to be managed by these professionals for a fee? "Thank you for your money, Mr. Investor, for the 1 per cent management fee that I earn. By the way I put your money into a Citibank 10-year note yielding 7 per cent. If you need any further advice, please do not hesitate to call"?

    I doubt the investors are paying those management fees to buy boring deposits and bonds, which they can do themselves. The investors in mutual funds want risk, they want returns. It's like there is no fear at all - just a lot of greed. No one worries abut how much they can lose, but most people seem to be worried about how much they will not make by staying out of markets. Those that stayed out of the US and European markets have lost a lot, and so even the last of the bears is now turning bullish and jumping in. Between 1 January and today, the index in the US has performed better than more than 90 per cent of the funds! Can you imagine the pressure on the fund manager who decided to stay out of markets because he expected a crash and hoped to get in cheap? He must be desperate to make up for his lost performance and plunge into the equity markets.

    It must be pretty stressful out there in the US and Europe, trying to do better than a market that refuses to pause and just gathers stream with every passing week based on the extremely critical and difficult judgment of future interest rates. Boy, am I glad to be in India, where the only call I have to make is when this government will fall, who will come to power, who will the prime minister, whether Chidambaram will be retained as finance minister in a Kesari-Laloo-Mayawati coalition, when the first CBI case against anyone will succeed, what the cost of Enron-generated power will be in 2002 AD, whether badla will be revived or not, when....



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