We are about to draw curtains to 2010. As we see now, the global economy seems in a better place than where it was at the end of last year. Emerging markets like India have seen a return to good economic growth. And the panic in the developed markets seems to have receded as well. Well, this is what it seems from the top. This is what will be the first impression of someone who fell asleep at the end of 2009, and woke up today.
But for those of us, who have seen things shaping up during the past 12 months of this year, we see things in a slightly different perspective. Global economies are growing, fine. Stock markets are rising, fine. Investors are not anymore in a shock, fine. And there's optimism all around.
But under these calm waters lie some tensions that are taking a bigger shape day after day. One tension – on the global level – is that of the impact of countries defaulting on their debt. This is mostly true for the European region. Policymakers there are finding ways to save troubled nations. But the risk is that there is a limit to which they can help by way of bailouts. If the contagion were to spread faster across Euro economies, things can get out of hand even for the shrewdest of economists and policymakers.
Talking about the US, hyper-inflation is what most investors are fearful about but are still keeping calm. The US central bank is doling out billions of dollars to save troubled banks, corporations, and consumers. In this process, they have kick-started a massive depreciation of the dollar (too much of a supply of something brings down its price, right?). This dollar deluge has the ability to trigger high inflation in the US economy, which would be detrimental to its citizens' future. What's even worse is that the central bank hasn't stopped on its quantitative easing schedule and is looking to dole out more freebies next year.
Let's come to India now. Whatever's happening here is also a mirror image of whatever's happening in most emerging markets. Foreign funds have led to stock prices surging here. And high inflation is ruling the roost. The problem with India is also its high current account deficit, which is 80% funded by short term FII inflows. Were these inflows to dry up in the future, the Indian economy could face a major trouble. As far as stock valuations are concerned, these don't look overtly expensive but aren't in the safe zone as well.
So overall, if the first half of 2010 was a period of recovery, the second half is recovery plus rising risks for the global and Indian economy. As such, you must be very careful in your stock picking. Any meaningful correction can give you chances to pick up good stocks at low valuations. But the idea must remain to stick with good stocks – well-managed companies with ethical managements.