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Stockmarkets: Under a cloud cover? - Views on News from Equitymaster
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  • Sep 24, 2007

    Stockmarkets: Under a cloud cover?

    The Asian stock markets, led by India, continue to make merry in light of the fresh dose of liquidity released by the US Federal Reserve in its latest monetary policy meeting held on September 18th. As Ben Bernanke announced the 50 basis points, or 0.5% reduction in the Fed funds rate, he let open a tap of new money that had been stuck up earlier owing to fears of a global financial crisis led by the US subprime rout.

    The Fed decision, however, did not have an all-round positive impact, as seen from the consequent weakness of the US dollar against major global currencies (as also the Indian rupee, which appreciated by 1.5% against the greenback last week) and also rise in US bond yields as investors feared a resurgence of inflation. The impact was also seen on commodity prices, especially with crude reaching an all-time high of US$ 83 per barrel. Even the gold prices soared on news of the Fed rate cut.

    With the global financial system still reeling under uncertainty of a further turmoil, performance of stocks can be highly volatile in the near term. And if one were to go by what Marc Faber the leading investment strategist has to say, the situation could worsen much before it gets better. Talking about the global credit crisis, he indicates, "Unlike all the Wall Street strategists who compare the current credit crisis to the credit crisis of 1998 (Long Term Capital Management), I believe that the ongoing credit problems will be far worse and of a longer-term nature. This will make it difficult for the market to reach new highs in the near future. Moreover, even if the 1998 comparison were to hold, we would still be looking at a much deeper stock market correction than the 22% sell-off we saw in 1998." Sounds fearful? Definitely!

    Mr. Faber goes on to say that the key difference between the situation now and the one in 1998 is that "the dollar looks extremely wobbly. In 1998, the US current account deficit was 2% of GDP; today, it's hovering around 8%. This massive deficit puts continuous pressure on the dollar. Moreover, gold and other commodities are in an uptrend. There is another reason why conditions today are very different from those in 1998: in 1998, total credit market debt to GDP was 250%; today, it's 330%. Since debt growth has been so strong in the last few years, and because the system is now far more leveraged than in 1998 (not to mention the derivatives market), a tidal wave of liquidity would be needed to bail out the system, which would have to lead to even stronger debt growth; but, obviously, it would only lead to even larger dislocations and problems later."

    As has been seen from the after effects of the interest rate cut in the US (we're not talking of the spike in emerging stock markets), further rate cuts from the Fed in the future could lead to an even weaker dollar (thus an appreciating rupee, hurting export led industries), higher inflation and rising long-term interest rates.

    The thought of this write-up is not to create a fear factor with respect to your stock market exposure, but to make you cautious as to the risks that could endanger your investments, if not handled properly. We have seen panic spread wildly in the recent subprime crisis in the US, which has been followed by a sudden bout of exuberance as to nothing can go wrong 'now'! The global financial system, of which India is an integral part, remains clouded by uncertainties. This is for you to understand clearly before you chart out an investment plan for yourself.



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